**UNITEDSTATES**

**SECURITIESAND EXCHANGE COMMISSION**

**Washington, D.C. 20549**

 

**FORM 10-K**

 

ý                                   **ANNUAL REPORT PURSUANT TO SECTION 13OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934**

 

**For the fiscal year ended December 31, 2005**

 

**OR**

 

o                                   **TRANSITION REPORT PURSUANT TO SECTION13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934**

 

**For the transition period from          to          .**

 

**Commission File No. 000-30617**

 

**GlobalSCAPE,Inc.**

(Exact name of registrant as specified in itscharter)

 

| **Delaware**                          | ** ** | **74-2785449**      |
|---------------------------------------|------------|---------------------|
| (State or other jurisdiction of       |       | (I.R.S. Employer    |
| incorporation or organization)        |       | Identification No.) |
|                                  |       |                |
| **6000 Northwest Parkway, Suite 100** | ** ** | ** **          |
| **San Antonio, Texas**                | ** ** | **78249**           |
| (Address of Principal                 |       | (Zip Code)          |
| Executive Office)                     |       |                |

 

**(210) 308-8267**

(Registrant’s Telephone Number, IncludingArea Code)

 

Securities registered pursuant to Section12(b) of the Act:

**None**

 

Securities registered pursuant to Section12(g) of the Act:

 

**Common Stock, par value $0.001 per share**

(Title of Class)

 

Indicate by check mark if theregistrant is a well-known seasoned issuer, as defined in Rule 405 of theSecurities Act.

 

o Yes    ý No

 

Indicate by check mark if theregistrant is not required to file reports pursuant to Section 13 or Section15(d) of the Act.

 

o Yes    ý No

 

Indicate bycheck mark whether the registrant (1) has filed all reports required to befiled by Section 13 or 15(d) of the Securities Exchange Act of 1934 during thepreceding 12 months (or for such shorter period that the registrant wasrequired to file such reports), and (2) has been subject to such filingrequirements for the past 90 days.

 

ý Yes    o No

 

Indicate by check mark if disclosure of delinquent filers pursuant toItem 405 of Regulation S-K (§ 229.405 of this chapter) is not contained herein,and will not be contained, to the best of registrant’s knowledge, in definitiveproxy or information statements incorporated by reference in Part III of thisForm 10-K or any amendment to this Form 10-K. o

 

Indicate by check mark whether the registrant is a large acceleratedfiler, an accelerated filer, or a non-accelerated filer. See definition of “acceleratedfiler and large accelerated filer” in Rule 12b-2 of the Exchange Act (checkone):

 

Large Accelerated filer o    Acceleratedfiler o    Non-Accelerated filer ý

 

Indicate by check mark if theregistrant is a shell company (as defined in Rule 12b-2 of the Act).

 

o Yes    ý No

 

The aggregatemarket value of the registrant’s outstanding common stock held bynon-affiliates was approximately $1,285,850 as of the last business day of theregistrant’s most recently completed second fiscal quarter, based upon theclosing sales price of $0.37 per share on such date on the NASD’s OTC BulletinBoard.

 

As of March 6,2006 there were 14,333,690 shares of common stock outstanding.

 

**Documents Incorporated by Reference**

 

Portions of the Registrant’sProxy Statement for the 2006 Annual Meeting of Stockholders to be held on June1, 2006, are incorporated by reference in Part III hereof.

 

 

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**TABLE OF CONTENTS**

 
| **PART I**   | ** **                                                                                                  |
|--------------|-------------------------------------------------------------------------------------------------------------|
|         |                                                                                                        |   |
| Item  1.     | Business                                                                                                    |   |
|         |                                                                                                        |   |
| Item 1A.     | Risk  Factors                                                                                               |   |
|         |                                                                                                        |   |
| Item 1B.     | Unresolved  Staff Comments                                                                                  |   |
|         |                                                                                                        |   |
| Item 2.      | Properties                                                                                                  |   |
|         |                                                                                                        |   |
| Item 3.      | Legal Proceedings                                                                                           |   |
|         |                                                                                                        |   |
| Item 4.      | Submission of Matters to a  Vote of Security Holders                                                        |   |
|         |                                                                                                        |   |
| Item 4A.     | Executive Officers of the  Company                                                                          |   |
|         |                                                                                                        |   |
| **PART II**  |                                                                                                        |
|         |                                                                                                        |   |
| Item 5.      | Market for  Registrant’s Common Equity and Related Stockholder Matters and Issuer  Purchases of Equity |   |
|         |                                                                                                        |   |
| Item 6.      | Selected Financial  Data                                                                                    |   |
|         |                                                                                                        |   |
| Item 7.      | Management’s  Discussion and Analysis of Financial Condition and Results of Operation                  |   |
|         |                                                                                                        |   |
| Item 7A.     | Quantitative  and Qualitative Disclosures About Market Risk                                                 |   |
|         |                                                                                                        |   |
| Item 8.      | Financial  Statements and Supplementary Data                                                                |   |
|         |                                                                                                        |   |
| Item 9.      | Changes in and Disagreements with  Accountants on Accounting and Financial Disclosure                       |   |
|         |                                                                                                        |   |
| Item 9A.     | Controls and  Procedures                                                                                    |   |
|         |                                                                                                        |   |
| Item 9B.     | Other Information                                                                                           |   |
|         |                                                                                                        |   |
| **PART III** |                                                                                                        |
|         |                                                                                                        |   |
| Item 10.     | Directors  and Executive Officers of the Registrant                                                         |   |
|         |                                                                                                        |   |
| Item 11.     | Executive  Compensation                                                                                     |   |
|         |                                                                                                        |   |
| Item 12.     | Security  Ownership of Certain Beneficial Owners and Management and Related Stockholder  Matters            |   |
|         |                                                                                                        |   |
| Item 13.     | Certain  Relationships and Related Transactions                                                             |   |
|         |                                                                                                        |   |
| Item 14.     | Principal  Accountant Fees and Services                                                                     |   |
|         |                                                                                                        |   |
| **PART IV**  |                                                                                                        |
|         |                                                                                                        |   |
| Item 15.     | Exhibits,  Financial Statement Schedules                                                                    |   |

 

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**PreliminaryNotes**

 

GlobalSCAPE®, CuteFTP®,CuteSITE Builder®, PureCMS®, CuteZIP®, CuteHTML® and CuteMAP® are registeredtrademarks of GlobalSCAPE Texas, LP.  GlobalSCAPE Secure FTP Server,GlobalSCAPE Transfer Engine, ContentXML and SnapEdit are trademarks ofGlobalSCAPE Texas, LP.  Other trademarks and tradenames in this Annual Reportare the property of their respective owners.

 

In this report, we use thefollowing terms:

 

“HTTP” or Hyper TextTransfer Protocol is a protocol commonly used to transfer hypertext documentsbetween a web server and a web browser.

 

“S/Key” is a security systemin which a one-time challenge-response password scheme is used to authenticateaccess to data. The purpose of S/Key is to eliminate the need for the samepassword to be sent over a network each time a password is needed for access.

 

“SSH2” or Secure Shell is aprotocol that provides encrypted network communications between two computers.

 

“SSL” or Secure Socket Layeruses cryptography to encrypt data between the web server and the web browser.

 

**Forward-LookingStatements**

 

This AnnualReport on Form 10-K and the documents incorporated by reference herein contain “forward-lookingstatements” within the meaning of Section 27A of the Securities Act of 1933, asamended, and Section 21E of the Securities and Exchange Act of 1934, as amended.“Forward-looking statements” are those statements that are not of historicalfact, but describe management’s beliefs and expectations. We have identifiedmany of the forward-looking statements in this Annual Report by using wordssuch as “anticipate,” “believe,” “could,” “estimate,” “may,” “expect,” and “intend.”  Although we believe these beliefs andexpectations are reasonable, our operations involve a number of risks anduncertainties, including those described in the “Risk Factors” section of thisAnnual Report and other documents filed with the Securities and ExchangeCommission. Therefore, GlobalSCAPE’s actual results could differ materiallyfrom those discussed in this Annual Report.

 

# **PARTI**

 

## **Item 1.**           Business

 

### **Company Overview**

### ** **

GlobalSCAPEdevelops and distributes secure file management software that enables users tosafely send data over the internet. Our products guarantee the privacy ofcritical information such as financial data, medical records, customer filesand other similar documents. In addition, our products ensure compliance withgovernment regulations relating to the protection of information while allowingusers to reduce IT costs, increase efficiency, track and audit transaction andautomate processes. We also develop and distribute Web content management andWeb development tools.

 

We started in1996 with the distribution of CuteFTP, a file transfer protocol client program,and have achieved significant success and popularity with this product. Webuilt on this success by steadily adding complementary products and believe wenow have a reputation as a provider of easy-to use, affordable software forboth individual and enterprise users. Since 2000, we have focused on enhancingour portfolio of products to meet the increasing demand for data security, andfor solutions that permit non-technical personnel to contribute content totheir organizations’ Web sites. Our software is used worldwide across a widerange of industries. Through the end of 2005, we had sold approximately1,300,000 software licenses and our customer base includes individualconsumers, small to medium-sized businesses, as well as some of the largestcorporations in the world.

 

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During 2005,approximately 67% of our revenues were generated from customers within theUnited States, with the remaining 33% concentrated mostly in Western Europe,Canada and Australia. Virtually all of our 2005 revenues were derived fromsales of software licenses and support agreements. The combined sales ofCuteFTP and CuteFTP Pro accounted for 69% and 50% of our revenues in 2004 and2005, respectively. Our combined sales of our Secure Server and Enhanced FileTransfer products grew from 14% of our revenues in 2004 to 43% in 2005.

 

### **Industry Background**

### ** **

The internethas become an integral part of operations for companies of all sizes, not onlyfor e-commerce, but also as a means of managing information between central andremote locations and with employees, partners and suppliers. Corporateinformation managers must protect business assets, ensure that policies andprocesses meet regulations governing the management of sensitive information,and ensure that the right people have access to the right information at theright time. Global operations, diverse business partners and networks furtheremphasize the need for common standards to ensure compatibility, scalabilityand cost-effective integration.

 

Organizationsthat use the internet for data transfer are also faced with a daunting array ofsecurity challenges stemming from various regulatory and business requirementsfor data privacy and confidentiality. Regulatory and privacy requirementsinclude legislation such as the Health Insurance Portability and AccountabilityAct (HIPAA), California Senate Bill (SB) 1386, and the Gramm-Leach-Bliley Act(GLBA) in the US, and the European Union’s Privacy Directive, some of whichimpose severe penalties for improper disclosure of confidential information. Additionally,industry best-practices and self-imposed business requirements includeintellectual property and trade secrets protection and controls regarding disclosureof proprietary information to minimize corporate risk from the devastatingconsequences of security breaches. As corporate Web operations mature, webelieve we will see an increasing demand for solutions to facilitate securefile transfers on the internet and for solutions that streamline the managementof Web content.

 

### **Products**

### ** **

Our currentproducts include Windows®-based, Mac based, browser-based and server softwareapplications.

 

**FTP Client Programs**

 

File transferprotocol, or FTP, is the language used for file transfers from computer tocomputer across the World Wide Web. FTP is most commonly used to download afile from a server using the internet or to upload a file to a server.

 

***CuteFTP*.**CuteFTP is a “client-side” program, meaning that it permits a user torequest a file from or send a file to an FTP server or host computer. The userbase for this program ranges from corporate MIS professionals who use it totransfer data between locations via the internet, to individual Web siteoperators who use it to upload their Web pages to their Web hosting provider. CuteFTPsimplifies use of file transfer protocol by hiding the technical processesbehind a user-friendly, graphical interface, which allows users to “drag ‘ndrop” files between computers. It includes an automatic reconnection featurethat resumes broken transfers, a transfer queue and a built in HTML editor thatallows remote editing of Web pages. CuteFTP has won several awards, includingthe CNet Editors’ Choice award, and has been favorably reviewed in leadingonline and print trade journals such as PC Magazine, WindowsNT, Yahoo InternetLife, CNet’s Download.com and Tucows, as being the most powerful, easy-to-usefile transfer protocol program available. We offer CuteFTP in German, French, Spanish,Japanese and Traditional and Simplified Chinese. CuteFTP was first released inFebruary 1995 by its original author, and was first distributed as a commercialproduct by GlobalSCAPE in April 1996. In October 2003, GlobalSCAPE releasedCuteFTP Mac, our easy-to use FTP client for the Macintosh operating system. CuteFTPMac incorporates many of the popular features of CuteFTP for Windows, whileadhering to Apple’s Aqua® interface and usability guidelines.

 

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***CuteFTP Pro*.**CuteFTP Pro is a secure FTP client program designed for advanced users andinformation technology professionals. CuteFTP Pro incorporates standards forencrypted transfers using Secure Socket Layer (SSL), HTTP, and SSH2, as well asadvanced S/KEY password encryption. It includes various features attractive toadvanced users such as multi-part and concurrent file transfers to maximizetransfer speed, scheduled file transfers, automated site backups and scriptingability for automating FTP tasks. CuteFTP Pro has been favorably reviewed byleading online publications including CNet’s Download.com, ZDNet and PC Review.CuteFTP Pro was released in March 2001 and CuteFTP MAC Pro was released in April2004.

 

**File Transfer Servers**

 

FTP transfersrequire two software programs:  a clientprogram to start a transfer and a server to accept the connection. FTP serversare designed to provide businesses with increased security and speedier filetransport when compared to e-mail.

 

*** Secure FTP Server*.**SecureFTP Server complements CuteFTP Pro and other professional FTP clients byenabling encrypted transfers using Secure Socket Layer (SSL), Secure Shell(SSH2) and advanced S/KEY password encryption. When used with CuteFTP Pro,Secure FTP Server offers a complete digital certificate management system,giving system administrators the ability to create, sign, import, export andadd digital certificates, as well as kick off back-end processes. The latterfunctionality can be used as a partial or total replacement for more complexenterprise-level electronic data interchange systems (EDI). Additional featuresinclude full remote management capability, the ability to operate multiple FTPsites with unique directory structures from a single server and manage user accountswith advanced restriction settings for maximum security and control. Secure FTPServer has been favorably reviewed by leading online publications includingServer Watch and File Forum. GlobalSCAPE Secure FTP Server was first releasedin January 2002.

 

***Enhanced FileTransfer Server.***Enhanced File Transfer Server isa hardened file server for enterprise-level solutions. Building on Secure FTPServer with digital certificate management, Secure Socket Layer (SSL) and S/KEYpassword encryption, remote administration, multiple site hosting andmanagement, and extensive automation with a full featured event rule libraryand Component Object Model (COM) extensions, Enhanced File Transfer Server addsrepository encryption, additional protocol support, SSH security, data offloadcapabilities, and automated notification. This product offers modules designedto be the solutions for our customer’s different needs. Enhanced File TransferServer was first released by GlobalSCAPE in November 2004. The latest version,EFT Server 4 helps customers achieve regulatory compliance with legislationsuch as HIPAA, Sarbanes-Oxley and Gramm-Leach by providing securityfunctionalities such as secure authentication, secure data transfers, securestorage and advanced encryption and signing. Enhanced File Transfer Serveroffers modules that can be added on to the product such as DMZ Gateway andSecure SMTP Gateway. DMZ Gateway, when combined with the EFT Server, adds amulti-layered security solution that allows implementing the highest levels ofsecurity for data storage and retrieval, authentication and firewalltransversal. Using a two-way connection originating from the back-end(internal) EFT server, the DMZ Gateway acts as a communication proxy to processrequests that replaces inherently insecure inbound connections from the DMZ toyour network. GlobalSCAPE’s Secure SMTP Gatewaytransparently secures outbound emails by holding sensitive messages and sendingan email notification to the recipient, who can then retrieve the message andany attachments over a secured HTTPS channel.

 

**Web Content Management**

 

Contentmanagement generally refers to software that streamlines the process formanaging information on a Web site or intranet.

 

***PublishXML***.PublishXML is our Web content management solution. PublishXML is designed tosolve basic problems endemic to maintaining current information on a Web sitesuch as bottlenecks in the IT department, lack of control and accountability,and miscommunication between content authors and Web developers. GlobalSCAPEmarkets the product on its website and provides all leads to Hannon-Hill

 

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Corp. Hannon-Hillacts as the sales agent for this product, and revenues from the sales are splitbased upon an agreement between the parties with all invoicing and collectionsbeing processed by GlobalSCAPE. Using PublishXML, developed by Hannon-Hill, acompany’s Web administrator may give non-technical personnel the ability todirectly revise designated content. For example, the marketing department couldmodify pricing, product descriptions and graphics while the human resourcesdepartment updated its job postings, all without the involvement of technicalpersonnel. Access by non-technical personnel is limited, however, so that theWeb site administrator’s ability to protect the overall infrastructure anddesign of the site is not compromised. The program is browser-based with aWindows-like interface, so users can easily access and work on Web sites,eliminating the need for special training. Changes are made to a copy of anorganization’s Web site in a staging area and published to the live site onlyafter group leaders or Web site administrators approve the content forpublishing. Additional features include WYSIWYG (what you see is what you get)editing, visual comparison of proposed changes to the live site, e-mailnotification of changes and activity, site statistics, versioning and archiving.PublishXML works with any Web site development tool including popularapplications such as Front Page and Dreamweaver, and can be implemented withoutdeconstructing (re-building) the existing Web site. The program is scaled tomeet the needs of small to medium-sized businesses, but can be used by largeorganizations for intranet or independent Web site management. PublishXML wasreleased in April 2004.

 

**Internet Products**

 

We offer a variety of software products whichcan be purchased and downloaded directly from our automated website. Theseproducts include products that range in price from $19.99 to $249.00 for asingle license. Products for web page content management and design includeCuteSITE Builder, CuteHTML, CuteHTML Pro and CuteMAP. We also offer a filecompression product, CuteZIP, and a product for conducting online surveys, WebSurvey.

 

These products are easy to install and use,making them good products to attract users to our website.

 

### **History and Recent Developments**

### ** **

GlobalSCAPE wasorganized as a Delaware corporation in April 1996 when we obtained the right todistribute CuteFTP from its original author. In 1998, we purchased all rightsto CuteFTP from its author and in 1999 began developing and sellingcomplementary products under the “Cute” brand such as CuteHTML and CuteMAP. InSeptember 2000, ATSI distributed approximately 27% of its GlobalSCAPE commonstock to its shareholders. As a result of this partial spin off, we became areporting company under the Securities Exchange Act of 1934. In June 2002, ATSIsold its remaining interest in the company to a San Antonio based jointventure.

 

Significantdevelopments during 2005 included:

 

•                  **February 2005**:  We announced availability of our Enhanced FileTransfer product at the HIMMS trade show for healthcare organizations.

 

•                  **March 2005**:  Thelatest versions of CuteFTP Home and CuteFTP Professional were released.

 

•                  **April 2005**:  Thelatest version of PureCMS Content Management software was released as a Hannon-Hillproduct. Hannon-Hill acts as our sales agent for PureCMS and PublishXML.

 

•                  **July 2005**: We released the latest version of EFT Server and thenew DMZ Gateway software.

 

•                  **August 2005**:  Wereleased Secure SMTP Gateway, a new email security software.

 

•                  **September 2005**:  We announcedthe sale of Secure FTP Server to the U.S. Army.

 

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### **Strategy**

 

Our goal is tobuild upon our successful market position in FTP, as we have for the past 10years, in order to provide business users with secure solutions for theirgrowing file transfer needs. We continue to enhance and develop high quality,affordable software that enables organizations and individuals to easilycreate, move and manage Web and file-based data in a secure, collaborativeenvironment. We have successfully established a brand in the market for internetsoftware productivity tools with our file management products, CuteFTP andCuteFTP Pro. We believe that the next phase of our growth will come through thecontinued development of our Secure FTP Server and Enhanced File Transferproducts involving secure file transfer to meet the growing demand for filesecurity when transferring information across the internet due to changes inregulations in various industries and the demand of users for secure solutions.GlobalSCAPE believes that our products represent a low cost solution forbusinesses for their secure file transfer requirements because we don’t requirethe purchase of a whole suite of products. Our Secure FTP Server andEnhanced File Transfer products offer modules to form the solutions a businessneeds, and they only need to purchase what solves their particular needs.Maintenance and support agreements are purchased with most of our higher-end serverproducts by businesses. We will also continue to market our content managementsolutions that help non-technical professionals manage their organization’s Websites without reliance on information technology professionals.

 

Key elementsof our strategy are:

 

***Continue to enhanceand develop security features of our products.***Corporateand individual users are increasingly concerned with security. We have addedthe Enhanced File Transfer (EFT) enterprise solution to our product line forbusinesses to meet the needs of security issues when transferring files in andout of their servers across the internet. We intend to continue to develop andadd features throughout 2006 to meet the demand for file transfer security inEFT and our other well known FTP products, CuteFTP Home and CuteFTPProfessional and Secure FTP Server. We intend to make the FTP, EFT and SecureFTP Server lines of business our main focus in 2006.

 

***Pursue strategicproduct and acquisition opportunities*.**In 2005, weadded modules and further developed our Secure FTP Server and EFT products. Wewill continue to look for opportunities to develop, acquire or add synergisticproducts or technologies that enhance the success of these products.

 

***Continue sales ofPublishXML.***We have invested considerable time andeffort in the marketing of PublishXML, our content management productintroduced in April 2004. We continue to believe that the demand for Webcontent management solutions is strong. We have released new versions of thisproduct and continue to evaluate all aspects of our management of this product,including pricing, ease of installation and use, program functionality, andmarketing and sales strategies. We intend to continue to pursue sales anddistribution of this product. In order to concentrate our efforts in this areaon PublishXML, we discontinued the sale of PureCMS through our sales agreementwith Hannon-Hill in 2005.

 

***Continue to developa more robust reseller channel*.**During 2005, wecontinued our emphasis on the development of our third party reseller channelsby hiring sales people with reseller sales backgrounds and developingrelationships with new resellers. In particular, we attempt to reach “value-added”resellers such as system design consultants. We believe sales will besignificantly enhanced if we are able to recruit numerous resellers who haveexisting relationships with prospective customers.

 

***Develop our internalsales staff****.*During2005, we continued the development of our internal direct sales force to bettersell our more complex products, such as Enhanced File Transfer, Secure FTPServer and PublishXML. We intend to continue to develop our sales staff throughfurther training and certification.

 

***Continue to developonline marketing capabilities****.*We believe we have significant expertisein driving online sales via online marketing activities, including productplacement on third party sites such as search engines and referral sites, andelectronic mail campaigns. This type of sales activity is particularly wellsuited to certain of our lower priced products because of the lower cost ofsale. We intend to continue to

 

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leverage our established Web presence to drive online sales as well assupporting our direct and reseller sales efforts.

 

### **Sales and Marketing**

### ** **

We sell oursoftware primarily via download from our Web site, **www.globalscape.com**. Prospective buyers may use our softwareproducts free for a thirty-day evaluation period. The programs areautomatically disabled if a license is not purchased by the end of the trialperiod. Our current products range in price from $19.95 to $25,000 per license.Historically, the majority of our software sales have been made online using acredit card. Our software is also available for download from a variety ofindependent internet software sites such as CNet’s Download.com, as well assites in Western Europe, Canada, Australia, and Asia. We distribute a limitednumber of copies on CD in Fry’s and Micro Center stores in the United Statesand through numerous international resellers. We provide free customer supportvia a searchable knowledge base on our Web site and sell “live” support andmaintenance packages.

 

Since 2003, wehave increased our emphasis on developing our internal sales staff and resellerchannels to capture those sales that require personal attention, such as salesof our more complex products and sales to larger enterprises. We requiretraining, testing and professional development of our sales people to insurethat they are capable of meeting the needs of our customers.

 

### **Seasonality**

### ** **

We believe our internet salesare subject to seasonal variations and we experience significantly less salesvolume during national holidays and weekends when compared to normal businessdays. In the fourth quarter of 2004, our sales revenues increased approximately11% over the same period in 2003, as a result of new product releases and oursales force development although sales declined from November 2004 to December2004. Our fourth quarter revenues in 2005 increased approximately 56% over thesame quarter in 2004. The seasonality we have experienced seems to be lesseningas we rely more on sales by our direct sales force, rather than our internetsales. We expect that in future periods we may see weakness in the fourthquarter on internet sales when compared to the third quarter, due to theholiday season.

 

### **Network and Equipment**

### ** **

We havecontracted with various network providers for internet access. Our arrangementsprovide for redundancy in the event of a failure, and also for rapid expansionof available bandwidth in the event that there is a dramatic increase in demand.To protect critical customer data, GlobalSCAPE’s secure server utilizes SecureSockets Layer encryption. We have dedicated servers on and off site andexpansion plans in place to allow rapid and cost effective scalability.

 

### **Research and Development**

### ** **

Our internalsoftware engineers are responsible for software design, managing thedevelopment process, testing and quality assurance. We utilize offshoredevelopers for a large portion of the coding phase of software development. Allphases of development, including scope approval, functional and implementationdesign, object modeling and programming, are subject to internal qualityassurance testing. Our use of external developers allows us to tap into ahighly skilled labor pool, maintain a 24-hour development schedule, decreasetime to market, and minimize programming costs.

 

For the years2003, 2004 and 2005, GlobalSCAPE spent approximately $945,000, $728,000 and$870,000 respectively, on research and development, all of which were expensed.

 

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### **Competition**

### ** **

The filemanagement, content management and Web development software market sectors areintensely competitive, subject to rapid change and are significantly affectedby new product introductions and other activities of market participants. Ourprimary competitors vary by product and are listed below.

 

***CuteFTP*.**CuteFTP exists in a highly competitive environment with several hundred FTPsoftware utilities available on the internet. We believe our primarycompetitors are WS_FTP from Ipswitch, Inc. and FTP Voyager by Rhino Software,Inc. CuteFTP was the second Windows-based FTP client to market and isconsistently the most frequently downloaded FTP client on popular downloadsites. CuteFTP Mac, our FTP client for the Macintosh platform, competes withFetch, by Fetch Softworks, Interachry, by StairwaysSoftware Pty Ltd., and Transmit FTP, by Panic Inc.

 

***CuteFTP Pro*.**CuteFTP Professional competes in the higher end of the same market asCuteFTP, targeting the security-minded IT professional. CuteFTP Professional ispositioned as one of the only secure FTP client programs that support a widerange of security standards related to the FTP protocol. Competitors in thegeneral FTP market offer products that support a smaller subset of thesesecurity standards and address a narrower segment of the secure FTP market. Competitorsinclude Van Dyke, Inc., Ipswitch, Inc., and Rhino Software, Inc.

 

***Secure FTP Server***.Secure FTP Server competes against a limited number of secure Windows-based FTPservers. We believe our primary competitors are WS_FTP Server and Serve-U. SecureFTP Server has the advantage of leveraging the success of CuteFTP Pro throughproduct integration, offering proprietary extensions to the FTP protocol, andcross-marketing efforts to an existing customer base.

 

***Enhanced FileTransfer Server.***Enhanced File Transfer Servercompetes in the managed file transfer server market. We believe our primarycompetitors are Tumbleweed, Sterling, Proginet, and SSH’s Tectia. Enhanced FileTransfer Server has the advantage of being very cost effective in its marketwhile leveraging and extending the security and file management features of ourother FTP products.

 

***CuteSITE Builder***.CuteSITE Builder competes against approximately one hundred WYSIWYG editors,including MS FrontPage, Macromedia’s Dreamweaver, HotMetal and HotDog. CuteSITEBuilder offers most of the features available in FrontPage, however, theproduct was developed to further simplify the Web site creation process and isarguably easier to use, better serving the novice. In addition, the product ispriced well below FrontPage.

 

***PublishXML***.The “content management” market is diverse and encompasses the areas ofknowledge management, document management, digital asset management and Webcontent management. PublishXML is designed for Web content management. Themarket for Web content management solutions for Fortune 500 companies and otherlarge organizations is dominated by companies such as Vignette, Interwoven,Documentum, Stellant and Microsoft, each of which offers solutions that cancost hundreds of thousands of dollars. We do not intend to compete in thismarket but are focused on small to medium-sized businesses with a simpler,affordably priced solution. We believe that we have a competitive advantage inthat we are better known than some of our competitors among technologyprofessionals who are already familiar with our file management programs,CuteFTP and CuteFTP Pro.

 

We offerPublishXML as a packaged solution. A “packaged solution” means that we licensea copy of the software to the customer for a one-time fee to install and use ontheir own servers. Our competitors include providers of online solutions, suchas Atomz, Crown Peak, and iUpload, and providers of packaged solutions,including Macromedia’s Contribute, Userland, Infosquare and Ektron. PublishXMLalso competes against software that incorporate subsets of Web contentmanagement functions in Web authoring programs, such as Microsoft’s FrontPage,and Macromedia’s Dreamweaver and Contribute.

 

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***Web Survey.***Competitiveproducts include both applications and services including Zoomerang,WebSurveyor, EZSurvey and SurveyMonkey. We believe Web Survey has an advantageof a lower total cost of ownership than the competition.

 

***CuteHTML*.**CuteHTML exists in a highly competitive environment with approximately onehundred text-based HTML editors. CuteHTML’s competition includes HomeSite fromAllaire, Inc. CuteHTML’s advantage is that it doesn’t add extraneous code toWeb pages, an attribute preferred by many professional Web masters.

 

***CuteHTML Pro***. CuteHTMLPro faces heavy competition from visual or “WYSIWYG” editors such as FrontPage, by Microsoft, Dreamweaver, by Macromedia Inc, and competition from otherdirect editors*,*such as Homesite,also by Macromedia Inc. CuteHTML Pro’s advantage is its appeal to professionalWebmasters who typically shun visual editors in favor of the extra features andadded control provided by direct editors such as CuteHTML Pro.

 

***CuteMAP*.**CuteMAP competes against approximately 65 image-mapping utilities, whichexist in a niche market. Primary competitors include CoffeeCup Image Mapper,Ulead Smart Saver and MapEdit. CuteMAP has the advantage of being able toleverage the success of CuteHTML through product integration andcross-marketing efforts to an existing customer base.

 

***CuteZIP*.**CuteZIP exists in the highly competitive file compression utility market,competing against several hundred file compression utilities. Its maincompetitors include WinZIP, the current market leader, and NetZIP. CuteZIP’smain advantage is that it is one of the only compression utilities offering128-bit encryption to secure compressed files. In addition, users can createself-extracting encrypted archives that recipients may open even if they don’thave a zip utility installed.

 

We havelimited information regarding our products’ market shares in their respectivecategories. Many of our competitors have substantially greater financial,technical, sales, marketing, personnel, and other resources, as well as greatername recognition and a larger customer base than we do. Significant competitioncharacterizes the markets for our products and we anticipate that we will faceincreasing pricing pressures from competitors in the future. Moreover, giventhat there are low barriers to entry into the software market, and the marketis rapidly evolving and subject to rapid technological change, we believe thatcompetition will persist and intensify in the future. We have experienced pricedeclines over the last several years. A reduction in the price of our productswould negatively affect gross margins as a percentage of net revenues, andwould require us to increase software unit sales, in order to maintain netrevenues at existing levels. For more discussion on the risks associated withour competition, you should read the information under “Risk Factors – RisksRelated to Operations – We face significant competition and competition in ourmarket is likely to increase” and “– GlobalSCAPE may not be able to competeeffectively with larger, better positioned companies, resulting in lowermargins and loss of market share.”

 

### **Intellectual Property**

### ** **

Our trademarks,copyrights and technology are central to our business. We protect ourintellectual property rights through a combination of licenses, trademarks,service marks, copyrights, trade secret laws and restrictions on disclosure.

 

We currentlyhave registered trademarks for GlobalSCAPE, CuteFTP, CuteFTP Pro, PureCMS,CuteHTML, CuteZIP, CuteMAP and CuteSITE Builder. We have obtained United Statescopyright registrations for all but the most recently developed versions of oursoftware applications, and have applied for registration for the most recentlydeveloped versions.

 

We seek toprotect our software, documentation and other written materials under tradesecret and copyright laws, which afford only limited protection. Despite ourefforts to protect our proprietary rights, unauthorized parties may attempt tocopy aspects of our products or to obtain and use information that we regard asproprietary. Policing unauthorized use of our products is difficult, and whilewe are unable to

 

8

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determine theextent to which piracy of our software products exists, software piracy can beexpected to be a persistent problem. In selling our products, we rely primarilyon click-wrap licenses that are not signed by licensees, and may beunenforceable under the laws of certain jurisdictions. In addition, the laws ofsome foreign countries do not protect our proprietary rights to as great anextent as do the laws of the United States. In addition, the number of patentsapplied for and granted for software inventions is increasing. Consequently,there is a growing risk of third parties asserting patent claims against us. Wehave received, and may receive in the future, communications from third partiesasserting that our products infringe, or may infringe, the proprietary rightsof third parties, seeking indemnification against such infringement orindicating that we may be required to obtain a license or royalty from suchthird parties. For more discussion on the risks associated with ourintellectual property, you should read the information under “Risk Factors,”especially “Risks Related to Legal Uncertainty.”

 

### **Employees**

### ** **

As of March 1,2006, we had 41 full-time and part-time employees organized within sevenfunctional areas. The employee distribution according to function is asfollows:

 
| **Department**                | ** ** | **Number of  Employees** | ** ** |
|-------------------------------|------------|-------------------------------|------------|
| Management and Administration |       | 7                             |       |
| Research and Development      |       | 4                             |       |
| Quality Assurance             |       | 2                             |       |
| Marketing                     |       | 7                             |       |
| Information Services          |       | 5                             |       |
| Sales                         |       | 10                            |       |
| Customer Support              |       | 6                             |       |

 

None of ouremployees are covered by collective bargaining agreements and we believe ouremployee relations are good.

 

###### **Item 1A.**                Risk Factors

 

We havedescribed below risks that we are aware of that could have a material adverseeffect on your stock ownership and our business.

 

**Risks Related to Operations**

 

***GlobalSCAPE depends on two products for asubstantial portion of its revenues.***

 

GlobalSCAPE depends on twoproducts, CuteFTP and CuteFTP Pro, for approximately 50% of its revenues. Inaddition, GlobalSCAPE’s ability to produce revenues related to other productsand new products depends substantially on exploiting the traffic to GlobalSCAPE’sWeb site generated by the demand for CuteFTP and CuteFTP Pro. If GlobalSCAPE isnot able to maintain its competitive position with these products, its revenuescould decline dramatically and GlobalSCAPE’s plans to expand its business couldbe substantially impaired. From 1996 to 2000, sales of licenses for CuteFTPincreased significantly year to year. From 2002 through 2004, combined revenuesrecognized from CuteFTP and CuteFTP Pro declined year to year. CuteFTP revenuedeclined approximately 22%, whereas CuteFTP Pro increased approximately 18%from 2004 to 2005. Although the percentage of combined revenue for CuteFTP andCuteFTP Pro has declined as compared to total revenues, actual revenues fromthese two products increased approximately 1% from 2004 to 2005. Substantiallyall software products ultimately reach a point in their lifecycle in whichsales can be expected to plateau or decline. While it cannot be determined withcertainty, these products may have reached such a point in their lifecycles. Ifwe are not successful in shifting a higher percentage of our revenues to ourother products and if sales of CuteFTP and Cute FTP Pro continue to remain flator decline, our revenues, cash flow from operations and net income willdecrease.

 

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***GlobalSCAPE’s newproduct introductions may fail to generate sufficient revenue.***

 

While we havehad success in introducing our EFT products through 2005, we will need tocontinue to market and enhance these products with new features and modules tomaintain our place in the market. If we fail to meet the needs of customers, ordelay the introduction of demanded features, we may lose sales to thecompetition. If revenues from CuteFTP and CuteFTP Pro decline and our newproducts fail to generate sufficient revenue to replace the declining revenues,our revenues, cash flow from operations and net income will decline.

 

***GlobalSCAPE may failto develop or license the intellectual property needed to launch new products.***

 

Our strategyfor future growth depends significantly on the addition of new products. If wefail to timely license, and/or develop new programs, or if our new programs arenot functionally competitive with other programs in our markets, our revenuegrowth could be substantially impaired.

 

***GlobalSCAPE may not be able to develop itssales force as needed to successfully market its new products.***

 

GlobalSCAPEhas relied heavily on internet sales in the past. However, our newer enterpriseprograms, Secure FTP Server, PublishXML and Enhanced File Transfer (EFT),require a more complex distribution model, including reliance on value-addedresellers such as Web development and system consultants. In addition, ourinternal sales force must be skilled at managing a complex and multi-stagesales process appropriate for these products. We have experienced some turnoveramong our internal sales personnel during 2005, resulting in training newpersonnel to take their place. Training new employees takes time and can resultin a loss of sales due to the technical skills that need to be gained in orderto sell our enterprise type software. Future turnover could have an immediateand direct effect on our revenues. Continued turnover, especially of keypersonnel, could cause revenues to decline dramatically.

 

***If GlobalSCAPE loses key personnel it may notbe able to execute its business plan.***

 

GlobalSCAPE’sfuture success depends on the continued services of key members of itsmanagement team. GlobalSCAPE did not experience turnover in its management teamduring 2005, which has been a key to moving our products and revenues forward. Theseindividuals are difficult to replace because of the intense competition forsimilarly skilled people. In addition, new members of the management team maynot be productive for weeks or months as they learn about GlobalSCAPE’sproducts and the administration within the Company.

 

***We face significant competition andcompetition in our market is likely to increase.***

 

The marketsfor our products are intensely competitive and characterized by rapidtechnological change. GlobalSCAPE’s competitors are constantly releasingimproved versions of their products. The needs and expectations of GlobalSCAPE’scustomers are also evolving. Therefore, GlobalSCAPE must continually enhanceits products and develop new products to remain competitive. When a new productis brought to market with functionality better suited to a particular use, thedemand for currently available products may decrease. All of GlobalSCAPE’sproducts are subject to the threat of reduced market share resulting from theintroduction of competitive products. GlobalSCAPE may fail to develop newproducts and functionalities as quickly as is necessary in the future to avoidlosing its position in the internet software market.

 

In addition,software development generally requires substantial lead-time, so GlobalSCAPEmust accurately predict what changes will be needed. GlobalSCAPE may fail topredict these changes far enough in advance, or it may not have sufficienttechnical personnel to make such changes. If GlobalSCAPE cannot keep pace, itsproducts will lose their position in the market.

 

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***GlobalSCAPE utilizes“open source” software in some of its products.***

 

The open source softwarecommunity develops software technology for free use by anyone. We have reliedon open source technology for the encryption features in our CuteFTP Pro andGlobalSCAPE Secure FTP Server products. Our reliance on open source codesoftware may impose limitations on our ability to commercialize our solutionand may subject us to possible intellectual property litigation.

 

Weincorporate a limited amount of open source code software into our solution,and we may use more open source code software in the future. Open source codemay impose limitations on our ability to commercialize our solution because,among other reasons, open source license terms may be ambiguous and may resultin unanticipated obligations regarding our solution, and open source softwarecannot be protected under trade secret law. In addition, it may be difficultfor us to accurately determine the developers of the open source code andwhether the acquired software infringes third-party intellectual propertyrights. As a result, we could be subject to suits by parties claiming ownershipof what we believe to be open source software. Claims of infringement ormisappropriation against us could be costly for us to defend and could requireus to seek to obtain licenses from third parties in order to continue offeringour solution, to re-engineer our solution or to discontinue the sale of oursolution in the event re-engineering could not be accomplished on a timelybasis. If this occurs, our business and operating results could be harmed.

 

Inaddition, from time to time there have been claims challenging the ownership ofopen source software against companies that incorporate open source softwareinto their products. We use a limited amount of open source software in oursolution and may use more open source software in the future. As a result, wecould be subject to suits by parties claiming ownership of what we believe tobe open source software. Any of this litigation could be costly for us todefend, hurt our results of operations and financial condition or require us todevote additional research and development resources to change our solution.

 

***Future governmentregulation may increase our cost of doing business and reduce demand for ourproducts***.

 

New laws maybe adopted to address areas such as taxation, privacy, copyrights, and qualityof services, and existing laws may be applied to the internet in unexpectedways. New laws and unexpected application of existing laws related to the internetcould create uncertainty in the internet market place, which could increase ourcost of doing business, reduce demand for our products, and have a materialadverse effect on our business, financial condition and operations.

 

***If an effective internetsales tax scheme is implemented, demand for our products could decrease.***

 

GlobalSCAPE isnot currently required to collect sales tax on its online sales except tocustomers in certain states. In general, state laws require that if the sellerdoes not collect sales tax, residents who purchase goods online should remitsales tax to the appropriate taxing agency in the state where they live. However,state agencies rarely enforce this rule and we believe that less than 1% of ourcustomers actually remit sales tax to their state taxing agencies. Forpractical purposes, most of our customers who do not pay sales tax to uspurchase their license on a tax-free basis. If an effective internet sales taxscheme is implemented it would effectively increase the cost of our software inthe eyes of our customers and therefore likely have a tendency to decreasedemand for our software.

 

***Taxes imposed byforeign governments may decrease demand for our products in those markets.***

 

On July 1,2003, the European Union (EU) enacted Value Added Taxes (VAT) on electronicpurchases. These taxes are charged to our non-business customers in the EUmember nations and rates vary by country. Western European countries accountfor a substantial portion of our international sales. These taxes, which varyin rate from 15% to 25%, may decrease demand for our products in these markets.Expansion in the number of the EU member nations may also decrease demand forour products as these taxes are imposed on more of our customers.

 

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***GlobalSCAPE may not be able to competeeffectively with larger, better-positioned companies, resulting in lower marginsand loss of market share.***

 

GlobalSCAPEcompetes with a variety of companies who have significantly greater revenuesand financial resources than GlobalSCAPE as well as greater personnel andtechnical resources. For example, CuteFTP and CuteFTP Pro compete with productsoffered by Ipswitch, Inc. and Microsoft Corporation, PureCMS competes withMacromedia Inc.’s software, and CuteSITE Builder competes with Microsoft andMacromedia software. Large companies may be able to develop new technologiesmore quickly than GlobalSCAPE, to offer a broader array of products, and torespond more quickly to new opportunities, industry standards or customerrequirements. For example, Macromedia’s Dreamweaver is one of the most popularWeb authoring programs for consumers and small businesses, providing them witha huge established customer base to which they are able to directly markettheir content management product, Contribute. Some competitors may also be ableto adopt more aggressive pricing strategies. For example, Ipswitch gives anolder version of its file transfer protocol program away for free fornon-commercial use, and Microsoft includes file transfer protocol functionalityin its internet browser, which it distributes for free. Increased competitionmay result in lower operating margins and loss of market share. Additionalcompetitors may enter the market and may have significantly greatercapabilities and resources than GlobalSCAPE. You should read the informationunder “Business-Competition” for more information on our competitors.

 

***It may be difficult for GlobalSCAPE torecruit software developers and other technical and management personnelbecause GlobalSCAPE is a relatively small company.***

 

GlobalSCAPEcompetes intensely with other internet software development and distributioncompanies internationally to recruit and hire from a limited pool of qualifiedpersonnel. Some qualified candidates prefer to work for larger, better knowncompanies. Failure to attract and maintain qualified personnel would impede ourdevelopment and maintenance of new and existing products.

 

***GlobalSCAPE’s ability to develop its softwarewill be seriously impaired if it is not able to use its foreign subcontractors.***

 

GlobalSCAPErelies on foreign subcontractors to help it develop its software. If theseprogrammers decided to stop working for GlobalSCAPE, or if GlobalSCAPE wereunable to continue using them because of political or economic instability,GlobalSCAPE would have difficulty finding comparably skilled developers. Inaddition, GlobalSCAPE would likely have to pay considerably more for the samework, especially if it used U.S. personnel. If GlobalSCAPE could not replacethe programmers, it would take it significantly longer to develop its products.

 

***GlobalSCAPEmay incur losses as it attempts to expand its business.***

*** ***

GlobalSCAPEintends to expand its business and therefore expects to expend significantadditional resources on developing its sales force, developing a more robustreseller program, research and development, marketing and product development. Asa result, GlobalSCAPE may need to expend significant resources to accomplishthese goals. If GlobalSCAPE fails to successfully develop and market newproducts or improve its direct and channel sales results, it may not be able toachieve the necessary revenue growth and may not be profitable.

 

***GlobalSCAPE’soperations are vulnerable to security breaches that could harm the quality ofits products and services or disrupt its ability to deliver its products andservices.***

*** ***

Third partiesmay breach GlobalSCAPE’s system security and damage its products and servicesor misappropriate confidential customer information. This might causeGlobalSCAPE to lose customers, or even cause customers to make claims onGlobalSCAPE for damages to them. In addition, GlobalSCAPE may be required toexpend significant resources to protect against security breaches and/or toaddress problems caused by such breaches.

 

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***GlobalSCAPE’sproducts may expose customers to invasion of privacy, causing customerdissatisfaction.***

*** ***

GlobalSCAPE’sSecure FTP Server and Enhanced File Transfer are intended to provide outsidersaccess to a customer’s computer, making the customer vulnerable to securitybreaches, which could result in the loss of their privacy or property. Ifcustomers suffer invasions of privacy or other harm, this may result incustomer dissatisfaction and possible claims against us for any resultingdamages.

 

***GlobalSCAPE’sproducts may contain defects that may be costly to correct, delay marketacceptance of its products and damage its reputation.***

*** ***

Errors may befound in GlobalSCAPE’s products after distribution. If errors are discovered,GlobalSCAPE may have to make significant expenditures of capital to eliminatethem and may not be able to correct them in a timely manner or at all. Errorsand failures in GlobalSCAPE’s products could result in a loss of, or delay in,market acceptance of its products and could damage its reputation.

 

***GlobalSCAPE’sproducts rely on the prevalence of Windows-based operating systems and if thattechnology fails to maintain or improve market share, GlobalSCAPE’s productswould not be as marketable.***

*** ***

Almost all ofGlobalSCAPE’s current software products can only be used on a Windows-basedoperating system and are not compatible with other operating systems. Anythingthat affects Windows market share negatively could have a material adverseeffect on the demand for GlobalSCAPE’s products.

 

***GlobalSCAPE’sinternal controls are limited, increasing the risk of employee mismanagement orerror.***

*** ***

All of ourfinance, accounting and SEC disclosure work is managed by a single officer,Thomas F. Farar, Chief Financial Officer, Secretary and Treasurer. Mr. Fararhas an accounting staff of two persons. Without an increase in staffing, it maystill be difficult for us to implement the types of internal controls that arecommon to larger corporations, and we therefore face a greater risk ofmismanagement or error in these areas.

 

**Risks Relatedto Stock Ownership**

** **

***Ourstock is a penny stock, which makes it more difficult to sell.***

*** ***

A “penny stock”is any stock which is not traded on a national exchange or quoted on NASDAQ andwhich falls below a selling price of $5.00 per share in the public market. Ourcommon stock is quoted on the NASD’s OTC Bulletin Board and not on an exchangeor the NASDAQ, and it has traded from $0.10 to $4.90 since it began activetrading in February 2002. The SEC’s penny stock rules require brokers anddealers to take certain steps before trading in a penny stock, making it moredifficult to sell a penny stock than other stock. A sale of penny stock doesnot usually take place as quickly as a sale of other stock. You may decide tosell your stock when the market price is desirable to you, but by the time thesale is complete, the price of the stock may have fallen to the point that thesale is no longer desirable. The price of penny stocks is typically morevolatile than other stocks, exacerbating this problem. Also, some brokers areunwilling to trade in shares of penny stocks.

 

***Our stock priceis/may be volatile.***

 

The tradingprice of our common stock has been and could continue to be subject to widefluctuations in response to certain factors, including:

 

•                  Quarter-to-quartervariations in results of operations;

 

•                  Ourannouncements of new products;

 

•                  Ourcompetitors’ announcements of new products;

 

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•                  Ourproduct development or release schedule;

 

•                  Generalconditions in the software industry; and

 

•                  Investorperceptions and expectations regarding our products, plans and strategicposition and those of our competitors and customers.

 

In addition,the public stock markets experience extreme price and trading volumevolatility, particularly in high-technology sectors of the market. Thisvolatility has significantly affected the market prices of securities of manytechnology companies for reasons often unrelated to the operating performanceof the specific companies. The broad market fluctuations may adversely affectthe market price of our common stock.

 

***We do not paydividends on our common stock.***

 

We have notpaid a dividend on our common stock and have no plan to do so in the nearfuture.

 

***Our principalshareholders may control our management decisions.***

 

Thomas Brown and David Mann, ownapproximately 70% of our outstanding common stock. Therefore, Messers Brown andMann are able to exercise significant influence over all matters requiringshareholder approval, including the election of directors and approval ofsignificant corporate transactions. This concentration of ownership may delayor prevent a change of control of GlobalSCAPE or discourage a potentialacquirer from attempting to obtain control of GlobalSCAPE, either of whichcould have an adverse effect on the value of our common stock.

 

***Anti-takeoverprovisions in GlobalSCAPE’s charter and Delaware law could inhibit others fromacquiring GlobalSCAPE.***

 

Some of theprovisions of GlobalSCAPE’s certificate of incorporation and bylaws and inDelaware law could, together or separately:

 

•                  discouragepotential acquisition proposals;

 

•                  delay or preventa change in control; and

 

•                  limit the pricethat investors may be willing to pay in the future for shares of GlobalSCAPE’scommon stock.

 

In particular,GlobalSCAPE’s certificate of incorporation and bylaws provide for, among otherthings, limitations on the individuals that may call meetings of thestockholders and do not allow for cumulative voting. GlobalSCAPE is alsosubject to Section 203 of the Delaware General Corporation Law, which generallyprohibits a Delaware corporation from engaging in any of a broad range ofbusiness combinations with any interested stockholder, as defined in thestatute, for a period of three years following the date on which thestockholder became an interested stockholder.

 

***Stockholders’ownership of GlobalSCAPE stock may be significantly diluted, affecting thevalue of the stock.***

*** ***

There areoptions for 2,058,600 shares currently outstanding under GlobalSCAPE’s employeestock option plans as of the date of this report. Of the 2,058,600 options,1,047,451 were vested as of March 1, 2006. We have filed a registrationstatement under the Securities Act of 1933, as amended (the “Securities Act”),covering stock issued upon the exercise of options by non-affiliates, and wemay file a registration statement covering options held by affiliates as well. Ifwe do not file a registration statement covering affiliates, affiliates whoexercise their options may choose to sell the stock under an exemption fromregistration, such as Rule 144 under the Securities Act. The exercise of theseoptions and sale of the resulting stock could depress the value of our stock.

 

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**Risks Relatedto Legal Uncertainty**

** **

***GlobalSCAPEis vulnerable to claims that GlobalSCAPE’s products infringe third-partyintellectual property rights particularly because GlobalSCAPE’s products arepartially developed by independent parties.***

*** ***

GlobalSCAPE maybe exposed to future litigation based on claims that GlobalSCAPE’s productsinfringe the intellectual property rights of others. This risk is exacerbatedby the fact that some of the code in GlobalSCAPE’s products is developed byindependent parties or licensed from third parties over whom GlobalSCAPE hasless control than it exercises over internal developers. In addition, we expectthat infringement claims against software developers will become more prevalentas the number of products and developers grows and the functionality ofsoftware programs in the market increasingly overlaps. Claims of infringementcould require GlobalSCAPE to re-engineer its products or seek to obtainlicenses from third parties in order to continue offering its products. In addition,an adverse legal decision affecting GlobalSCAPE’s intellectual property, or theuse of significant resources to defend against this type of claim could place asignificant strain on GlobalSCAPE’s financial resources and harm itsreputation.

 

***GlobalSCAPEmay not be able to protect its intellectual property rights.***

*** ***

GlobalSCAPE’ssoftware code, and trade and service marks are some of GlobalSCAPE’s mostvaluable assets. Given the global nature of the internet and GlobalSCAPE’sbusiness, GlobalSCAPE is vulnerable to the misappropriation of thisintellectual property, particularly in foreign markets, such as China andEastern Europe, where laws or law enforcement practices are less developed. Theglobal nature of the internet makes it difficult to control the ultimatedestination or security of GlobalSCAPE’s software making it more likely thatunauthorized third parties will copy certain portions of GlobalSCAPE’sproprietary information or reverse engineer the proprietary information used inits programs. If GlobalSCAPE’s proprietary rights were infringed by athird-party, and GlobalSCAPE did not have adequate legal recourse, GlobalSCAPE’sability to earn profits, which are highly dependent on those rights, would beseverely diminished.

 

***Othercompanies may own, obtain or claim trademarks that could prevent, limit orinterfere with GlobalSCAPE’s use of its trademarks.***

*** ***

GlobalSCAPE’svarious trademarks are important to its business. If GlobalSCAPE were to losethe use of any its trademarks, its business would be harmed and GlobalSCAPEwould have to devote substantial resources towards developing an independentbrand identity. Defending or enforcing GlobalSCAPE’s trademark rights at alocal and international level could result in the expenditure of significantfinancial and managerial resources.

 

###### **Item 1B.**                Unresolved Staff Comments

###### ** **

None.

 

## **Item 2.**           Properties

## ** **

Our corporateoffice is located in a technical park in northwest San Antonio calledUniversity Park Tech Center II. Our lease for the 14,700 square foot facilityexpires in September 2008. Our annual rent is approximately $191,000. Webelieve these facilities will be suitable for our current business needs andthat suitable additional space will be available on acceptable terms whenneeded.

 

## **Item 3.**           Legal Proceedings

 

We are notcurrently involved in any material pending legal proceedings, but may becomesubject to legal proceedings in the ordinary course of our business. Suchclaims may result in the expenditure of significant financial and managerialresources.

 

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## **Item 4.**           Submission of Mattersto a Vote of Security Holders

## ** **

None.

 

###### **Item4A.**                ExecutiveOfficers of the Company

###### ** **

***Charles R. Poole***.Mr. Poole has served as GlobalSCAPE’sPresident since February 2004. From September 2003 until February 2004, heserved as the company’s Vice President of Sales and Marketing. Mr. Poole hasover twenty years of experience in senior management and sales withtelecommunications companies, most recently as the President of GlobalSCAPE’sformer parent company, ATSI Communications, Inc., from 1998 – 2001. Mr. Poolehas served as a Senior Vice President for A+ Communications, responsible forpaging, cellular and telemessaging sales from 1995 – 1997, as General Managerof American Paging, Texas from 1994 – 1995, as a Division Manager of DataDocuments, Inc. of Omaha, Nebraska from 1992 – 1994, as President of GeoComPartners, a satellite-based telecommunications company from 1989 – 1992, asSenior Vice President of MobileComm (a BellSouth Company) from 1984-1989, andas Regional Vice President of Burroughs Corp (now Unisys) from 1966-1984.

 

***Thomas F. Farar.***Mr.Farar serves as GlobalSCAPE’s Treasurer, Secretary, and Chief Financial Officer.He is responsible for all finance and accounting functions. Mr. Farar joinedGlobalSCAPE in June 2004. Prior to joining GlobalSCAPE, Mr. Farar served asSenior Accounting Manager (1999-2003) and Controller (2003-2004) for UDP, Ltd.,a telecommunications service bureau. Mr. Farar also served as DisbursementsSupervisor for PG&E Gas Transmission – Texas in 1999. Mr. Farar wasController and Treasurer of CDH Feeders, Inc., an agricultural operation ofcattle feedlots, and affiliated companies from 1991-1998. Mr. Farar holds aB.B.A. in Accounting from The University of Texas at San Antonio.

 

***Jeffrey Gehring****.*Mr. Gehring servesas GlobalSCAPE’s Vice President of Sales and has been with GlobalSCAPE sinceNovember 2004 in that capacity. Mr. Gehring is responsible for the company’sinbound sales, corporate sales and the reseller program. Mr. Gehring wasemployed by Nextel Partners as Director of Sales in 2004, where he coordinatedsales across the country. From 2003 to 2004, Mr. Gehring was Sales Manager forGlobalSCAPE, performing the duties he presently holds. From 2002 to 2003, Mr.Gehring was a principal in a start up business, ConnectOne Telecom, where gotthe business off the ground from the organizational stage to operations. Priorto 2002, Mr. Gehring was Director of Sales and Marketing at UDP, a telecommunications billing, ordermanagement and customer service software company. Inaddition to his UDP experience, he has more than 20 years of operational andsales management experience in large and medium-sized businesses, includingUnisys, Bell South and Metrocall. His experience includes strategic planningand implementation for companies that require rapid growth, as well asestablishing processes and policies that foster world-class salesorganizations.

 

***Gregory Hoffer.***Mr. Hoffer serves as Vice President and ChiefTechnology Officer and has been employed by GlobalSCAPE since May 2000. Mr.Hoffer is responsible for overseeing all software development and Webdevelopment at GlobalSCAPE. Before joining GlobalSCAPE, Mr. Hoffer heldsoftware development positions at the consulting firm of Marotz, Inc. Prior tothat, Mr. Hoffer managed the IT department and was head of the computer sciencedepartment at Saint Mary’s Hall, a private school in San Antonio, Texas. Mr. Hofferreceived a bachelor’s degree in computer science from Trinity University and ispursuing his master’s degree in computer science.

 

***Stefan Lagmark.***Mr. Lagmark serves as Vice President ofMarketing. Mr. Lagmark has been with GlobalSCAPE since August 2004 and isresponsible for the overall marketing strategy of GlobalSCAPE. From 2002 to2004, Lagmark was a principal in Lagmark Business Brokers, where he marketedthe company’s services of brokering businesses in San Antonio, Texas and the surroundingarea. Prior to 2002, he held the position of National Sales Manager ofGallagher Power Fence, and has held several senior management positions withmultinational corporations, including that of Director of Marketing and Salesof T-Systems International, a large agricultural irrigation company and GeneralManager of Glo-Vet Supply, a distribution company of animal and veterinariansupplies, and a subsidiary

 

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of De Laval. In these leadership positions,he successfully achieved growth in sales and profitability through innovativemarketing programs, product and brand management, new distribution developmentand new market development. Stefan earned his Master’s degree in Economics andBusiness Administration from Stockholm School of Economics, Sweden.

 

***K. Earl Posey.***Mr. Posey serves as GlobalSCAPE’s VicePresident of Strategic Development. Mr. Posey is responsible for locatingtechnologies, partners and/or companies that fit within GlobalSCAPE’sstrategies and developing relationships that will grow GlobalSCAPE’s business. Priorto joining GlobalSCAPE in January of 2006, he was Vice-president ofAdministration for ATSI, Inc. an international telecommunications companylocated in San Antonio, from 2000-2003. During 2004 and 2005, he was the SeniorPrincipal and founder for Gossyppia Partners, a management consulting firmspecializing in development of strategic management plans for corporations. Mr.Posey did his graduate and post graduate work at Vanderbilt University.

 

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# **PARTII**

 

## **Item 5.**           Market for Registrant’sCommon Equity and Related Stockholder Matters and Issuer Purchases of Equity

 

Our common stock is listed on the NASD’s OTC Bulletin Board under thesymbol GSCP. As of February 22, 2006, there were approximately 2,550 holders ofrecord of our common stock representing approximately 9,000 beneficial owners. GlobalSCAPEstock began trading on February 15, 2002. The table below sets forth thequarterly high and low bid prices for our common stock for the last two fiscalyears.

 

### **Common Stock Price**

 
| ** **                               | ** ** | **Fiscal Year ended December 31,** | ** ** |
|------------------------------------------|------------|------------------------------------|------------|
| ** **                               | ** ** | **2004**                           | ** ** | **2005** | ** ** |
| ** **                               | ** ** | **High**                           | ** ** | **Low** | ** ** | **High** | ** ** | **Low** | ** ** |
| **First  Quarter (ending March 31)**     |       | $                                  | 0.27       |   | $ | 0.16 |   | $ | 0.32 |   | $ | 0.16 |   |
| **Second  Quarter (ending June 30)**     |       | $                                  | 0.18       |   | $ | 0.10 |   | $ | 0.40 |   | $ | 0.25 |   |
| **Third  Quarter (ending September 30)** |       | $                                  | 0.18       |   | $ | 0.10 |   | $ | 3.00 |   | $ | 0.31 |   |
| **Fourth  Quarter (ending December 31)** |       | $                                  | 0.21       |   | $ | 0.13 |   | $ | 4.90 |   | $ | 1.08 |   |
|                                     |       |                               |       |   |   |   |   |   |   |
| **Annual**                               |       | $                                  | 0.27       |   | $ | 0.10 |   | $ | 4.90 |   | $ | 0.16 |   |

 

The closingbid price on March 6, 2006 was $2.72. Over-the-counter market quotationsreflect inter-dealer prices, without retail mark-up, mark-down, or commissionand may not necessarily represent actual transactions.

 

We have neverpaid a cash dividend, and do not expect to do so in the foreseeable future. Weexpect to reinvest all of our earnings in the further growth of the business.

 

18

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## **Item 6.**           Selected Financial Data

## ** **

The selectedfinancial data presented below for the years ended December 31, 2001, 2002, 2003,2004 and 2005 are derived from our audited financial statements.

 

**Statement of Operations Data:**

 

| ** **                                                                            | ** ** | **Years ended December 31,** | ** ** |
|---------------------------------------------------------------------------------------|------------|------------------------------|------------|
| ** **                                                                            | ** ** | **2001**                     | ** ** | **2002** | ** ** | **2003** | ** ** | **2004** | ** ** | **2005** | ** ** |
| Revenues:                                                                             |       |                         |       |   |   |   |   |   |   |   |   |
| Software product revenues                                                             |       | $                            | 5,242,760  |   | $ | 5,186,824 |   | $ | 4,734,105 |   | $ | 4,713,191 |   | $ | 6,096,045 |   |
| Maintenance and support (net of deferred  revenue)                                    |       | 16,388                       |       | 82,679 |   | 113,014 |   | 217,469 |   | 737,003 |   |
| Advertising revenues                                                                  |       | 38,540                       |       | — |   | — |   | — |   | — |   |
| Total revenues                                                                        |       | 5,297,688                    |       | 5,269,503 |   | 4,847,119 |   | 4,930,660 |   | 6,833,048 |   |
| Operating expenses:                                                                   |       |                         |       |   |   |   |   |   |   |   |   |
| Cost of revenues (exclusive of depreciation  and amortization shown separately below) |       | 323,309                      |       | 353,918 |   | 532,910 |   | 371,242 |   | 279,964 |   |
| Selling, general and administrative                                                   |       | 3,551,498                    |       | 3,580,361 |   | 3,613,759 |   | 3,456,598 |   | 3,989,372 |   |
| Research and development                                                              |       | 1,176,714                    |       | 848,212 |   | 945,395 |   | 727,423 |   | 869,155 |   |
| Depreciation and amortization                                                         |       | 546,017                      |       | 544,063 |   | 390,154 |   | 171,834 |   | 98,071 |   |
| Settlement with ATSI Comm. Inc.                                                       |       | —                       |       | 392,905 |   | — |   | — |   | — |   |
| Total operating expenses                                                              |       | 5,597,538                    |       | 5,719,459 |   | 5,482,218 |   | 4,727,097 |   | 5,236,562 |   |
| Income (loss) from operations                                                         |       | (299,850                     | )          | (449,956 | ) | (635,099 | ) | 203,563 |   | 1,596,486 |   |
| Interest expense, net                                                                 |       | 4,420                        |       | 11,783 |   | (5,016 | ) | (1,651 | ) | (620 | ) |
| Interest income                                                                       |       | —                       |       | — |   | — |   | — |   | 10,685 |   |
| Gain (loss) on sale of assets                                                         |       | —                       |       | — |   | (1,486 | ) | — |   | 1,242 |   |
| Income (loss) before provision for income  taxes                                      |       | (295,430                     | )          | (438,173 | ) | (641,601 | ) | 201,912 |   | 1,607,793 |   |
| Total income tax provision (benefit)                                                  |       | (38,295                      | )          | 175,202 |   | 1,400 |   | 1,489 |   | 66,611 |   |
| Net income (loss)                                                                     |       | $                            | (257,135   | ) | $ | (613,375 | ) | $ | (643,001 | ) | 200,423 |   | 1,541,182 |   |
| Net income (loss) per common share - basic                                            |       | $                            | (0.02      | ) | $ | (0.05 | ) | $ | (0.05 | ) | $ | 0.01 |   | $ | 0.11 |   |
| Net income (loss) per common share  -assuming dilution                                |       | $                            | (0.02      | ) | $ | (0.05 | ) | $ | (0.05 | ) | $ | 0.01 |   | $ | 0.10 |   |

** **

**BalanceSheet Data:**

 

| ** **                                                                | ** ** | **December 31,** | ** ** |
|---------------------------------------------------------------------------|------------|------------------|------------|
| ** **                                                                | ** ** | **2001**         | ** ** | **2002** | ** ** | **2003** | ** ** | **2004** | ** ** | **2005** | ** ** |
|                                                                      |       |             |       |   |   |   |   |   |   |   |   |
| Cash and cash equivalents                                                 |       | $                | 134,537    |   | $ | 480,609 |   | $ | 342,433 |   | $ | 572,959 |   | $ | 2,029,473 |   |
| Working capital                                                           |       | 498,134          |       | 368,567 |   | 19,203 |   | 341,749 |   | 1,835,832 |   |
| Total assets                                                              |       | 2,009,806        |       | 1,412,042 |   | 918,278 |   | 971,857 |   | 2,901,671 |   |
| Long term debt including capital lease  obligations, less current portion |       | 77,080           |       | 15,477 |   | — |   | — |   | — |   |
| Cash dividends per common share                                           |       | $                | —     |   | $ | — |   | $ | — |   | $ | — |   | $ | — |   |

 

19

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## **Item 7.**           Management’s Discussionand Analysis of Financial Condition and Results of Operation

 

The followingManagement’s Discussion and Analysis of Financial Condition and Results ofOperations should be read in conjunction with our financial statements for theyears ended December 31, 2003, 2004 and 2005 and related notes includedelsewhere in this document.

 

**Overview**

 

GlobalSCAPEdevelops and distributes secure file management software that enables users tosafely send data over the internet. Our products guarantee the privacy ofcritical information such as financial data, medical records, customer filesand other similar documents. In addition, our products ensure compliance withgovernment regulations relating to the protection of information while allowingusers to reduce IT costs, increase efficiency, track and audit transaction andautomate processes. We also develop and distribute Web content management andWeb development tools.

 

Since 2000, wehave focused on enhancing our portfolio of products to meet the increasingdemand for data security, and for solutions that permit non-technical personnelto contribute content to their organizations’ Web sites. Our strategy is tocontinue enhancing our file transfer products across the board to meet thedemands of both individual and enterprise users, while improving the securityfeatures of our current product line. We believe that the next phase of ourgrowth will come through the continued development of our secure FTP Server andEnhanced File Transfer products involving secure file transfer to meet thegrowing demand for file security when transferring information across theinternet due to changes in regulations in various industries and the demand ofusers for secure solutions. We are encouraged with the interest we have seen inour enhanced file transfer offerings so far, with sales exceeding ourexpectations. We intend to release new versions of CuteFTP, CuteFTP Pro andSecure FTP Server early in 2006 and we believe we can slow the decline in salesof CuteFTP and improve sales of CuteFTP Pro and Secure FTP Server. We plan onreleasing additional versions of EFT and modules for it throughout 2006.

 

Substantiallyall software products ultimately reach a point in their lifecycle in whichsales can be expected to plateau or decline. Management believes that themarket for stand-alone FTP client programs for home consumers may be declining.While it cannot be determined with certainty, CuteFTP and CuteFTP Pro may havereached such a point in their lifecycles. In order to respond to this decline,we have begun concentrating on product offerings for business users. We havenot seen the same decline in the market for secure FTP client programs andservers such as CuteFTP Pro and Secure FTP Server which we believe bettertarget the needs of businesses.

 

Our shift to emphasizingproduct offerings for business users will have important consequences for ourbusiness. GlobalSCAPE will require more technical sales and support persons tohandle the complex configurations of customer systems as the customer basegrows. More difficult and different situations will arise as customer needsgrow. We will need to have the ability to understand and solve technical issuesin a timely manner. With increased sales to business we should realizeadditional revenues from maintenance and support agreements to support theadditional personnel.

 

##### **Liquidity and Capital Resources**

##### ** **

Our capitalrequirements are driven principally by our need to enhance our existingproducts and to develop new products. The amount of our capital expenditureshas a direct impact on our ability to offer enhanced and new products to ourcustomers. Our principal source of capital is cash flow from operations which,in turn, is highly dependent on our sales revenue. Historically, we have reliedheavily on sales of CuteFTP Home and CuteFTP Professional, which accounted for69% and 50% of our revenues in the years ended December 31, 2004 and 2005,respectively. Newer products in 2005, namely Enhanced File Transfer and Secure FTPServer, have increased our total revenue while reducing the percentage of totalrevenue previously held by the two CuteFTP products.

 

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Our principalsources of capital are cash on hand and cash flow from operations. To theextent that sales decline, our cash flow from operations will also decline. Ifsales decline or our liquidity otherwise requires, management may substantiallyreduce personnel and personnel-related costs, reduce or substantially eliminatecapital expenditures and/or reduce or substantially eliminate research anddevelopment expenditures.

 

Net cashprovided (used) by operating activities was ($105,548), $384,314 and $1,549,636in 2003, 2004 and 2005, respectively. Net cash used in operating activities in2003 was primarily the result of the net loss for the period offset somewhat bydepreciation and amortization charges for the period. In 2004, net cashprovided resulted from an increase in net income primarily as a result ofincreased revenues, adjustments related to depreciation and amortization aswell as decreased accounts receivable. Net cash provided by operatingactivities in 2005 was primarily due to an increase in net income primarily asa result of increased revenues, offset by an increase in accounts receivable,accrued liabilities and deferred revenue and a decrease in accounts payable.

 

Net cash usedin investing activities for 2003, 2004 and 2005 was $73,207, $42,250, and $102,062respectively. In 2003, 2004 and 2005, we capitalized the purchase of $73,027,$42,250 and $103,304 in equipment and software, respectively.

 

Net cashprovided (used) in financing activities during 2003, 2004 and 2005 was $40,399, ($111,538) and $8,940, respectively. In 2003, we made principalpayments of $61,317 on capital lease obligations and borrowed $100,000 underour line of credit and received $1,716 for the exercise of stock options. In2004, we made principal payments on notes payable of $100,000 and madeprincipal payments of $15,294 on capital lease obligations and received $3,756for the exercise of stock options. In 2005, we received $8,940 for the exerciseof stock options. We did not enter into any new capital leases in 2004 or 2005.

 

As of December31, 2005, we had $2,029,473 in cash and cash equivalents, current assets of $2,685,505and current liabilities of $849,673, resulting in working capital of $1,835,832.This represented a working capital improvement of $1,494,083 over December 31,2004. Our principal commitments at December 31, 2005, consisted of obligationsoutstanding under operating leases as well as royalty agreements with thirdparties. The commitments related to royalty agreements are contingent on salesvolumes. We plan to expend significant resources on product development infuture periods and may also use our cash to acquire or license technology,products or businesses related to our current business. We expect thatoperating expenses will continue to be a material use of our cash resources aswell, but will manage the business based on the immediately foreseeableoperating cash flows. The facility that we currently occupy is expected to besufficient for the next twelve months. Consequently, we do not anticipatesignificant expenditures for leasehold improvements or furniture for 2006.

 

We do notcurrently have any commitments for outside sources of capital. At December 31,2005, we had a $250,000 revolving credit agreement which expires on March 31,2006. We believe that, if necessary, we could enter into a similar arrangementin the future, although we cannot assure you that we will be able to do so. Wemay also sell equity securities in order to finance future acquisitions orlicensing activities.

 

The followingtable summarizes our contractual obligations at December 31, 2005, consistingof future minimum capital lease payments and future minimum payments underoperating leases: 

 
| ** **                   | ** ** | **Payments due by period** | ** ** |
|------------------------------|------------|----------------------------|------------|
| **Contractual obligations**  | ** ** | **Total**                  | ** ** | **Less than 1  year** | ** ** | **1-3 years** | ** ** | **3-5 years** | ** ** | **More than  5 years** | ** ** |
| Operating  lease obligations |       | $                          | 476,647    |   | $ | 190,659 |   | $ | 285,988 |   | $ | — |   | $ | — |   |
| Deferred  compensation       |       | $                          | 12,121     |   | — |   | $ | 12,121 |   | — |   | — |   |
| Total                        |       | $                          | 488,768    |   | $ | 190,659 |   | $ | 298,109 |   | $ | — |   | $ | — |   |

 

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##### **Critical Accounting Policies**

 

***Use ofEstimates***

* *

Management’sDiscussion and Analysis of Financial Condition and Results of Operations isbased upon the Company’s financial statements, which have been prepared inaccordance with accounting principles generally accepted in the Unites States. Thepreparation of these financial statements requires management to make estimatesand assumptions that affect the reported amount of assets and liabilities. Onan ongoing basis, management evaluates its estimates and judgments, includingthose related to revenue recognition, allowance for doubtful accountsreceivable, long-lived and intangible assets, income taxes and contingencies. Managementbases its estimates on historical experience, observable trends, and variousother assumptions that are believed to be reasonable under the circumstances. Managementuses this information to make judgments about the carrying values of assets andliabilities that are not readily apparent form other sources. Actual resultsmay differ from the estimates under different assumptions or conditions.

 

Managementbelieves the following critical accounting policies affect its more significantjudgments and estimates used in the preparation of its financial statements.

 

***RevenueRecognition***

* *

Our revenue is generatedprimarily by licensing our software products and providing support for thoseproducts. Revenues are comprised of the gross selling price of thesoftware, including shipping charges and the earned portion of support andmaintenance agreements. In periods where we had revenue from advertising, werecognized the net proceeds received from advertisers as revenue. The Companyrecognizes revenue in accordance with the American Institute of CertifiedPublic Accountants Statement of Position (“SOP”) 97-2, *Software Revenue Recognition*, as modifiedby SOP 98-9, *Modification of SOP 97-2,Software Revenue Recognition, With Respect to Certain Transactions*.

 

Revenues fromthe sale of software products are recognized and completely earned uponshipment or electronic delivery of the product provided that persuasiveevidence of an arrangement exists, collection is probable, payment terms arefixed and determinable and no significant obligations remain. The majority ofour sales are delivered electronically via email.

 

We also selltechnical support and maintenance agreements (post contract customer support “PCS”),which are sometimes bundled with the software. When vendor specificobjective evidence (“VSOE”) of fair value exists for all elements in a multipleelement arrangement, revenue is allocated to each element based on the relativefair value of each of the elements. VSOE of fair value is established by theprice charged when the same element is sold separately. In a multiple elementarrangement whereby VSOE of fair value of all undelivered elements exists butVSOE of fair value does not exist for one or more delivered elements, revenueis recognized using the residual method. Under the residual method, the fairvalue of the undelivered elements is deferred and the remaining portion of thearrangement fee is recognized as revenue, assuming collection is probable. Revenueallocated to PCS is recognized ratably over the contractual term, typically oneyear. We sometimes sell installation and training services with our PureCMS andEFT products. Revenue for installation and training is recognized whenperformed.

 

The Companybegan selling technical support and maintenance services for some of itssoftware products in 2001. Deferred revenue grew to a balance of approximately$142,000 at December 31, 2002 and remained relatively flat, ending 2003 with abalance of approximately $140,000. Sales of these agreements grew in 2004 and2005 with higher priced support and maintenance for our enterprise classsoftware products and our efforts to renew agreements upon their expiration. Growthin the sales of maintenance and support agreements may result in the deferredrecognition of a significant amount of revenue in future periods.

 

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***Allowancefor Doubtful Accounts***

*** ***

We providecredit, in the normal course of business, to a number of companies and performongoing evaluations of our credit risk. We require no collateral from ourcustomers and we estimate the allowance for uncollectible accounts based on ourhistorical experience and current credit evaluations. No single customeraccounted for more than 2% of net revenues in 2003 or 2004. In 2005, we had onecustomer that accounted for approximately 2.6% of net revenues.

 

***Valuationof Long-Lived and Intangible Assets***

* *

The Companyassesses the impairment of long-lived and intangible assets whenever events orchanges in circumstances indicate that the carrying value may not berecoverable. Factors considered important which could trigger an impairmentreview included the following: significant underperformance relative to historical or projected futurecash flows; significant changes in the manner of use of the assets or thestrategy for the overall business; and significant negative industry trends. Whenmanagement determines that the carrying value of long-lived and intangibleassets may not be recoverable, impairment is measured based on the excess ofthe assets’ carrying value over the estimated fair value. No impairment wasrecognized in 2003, 2004 or 2005.

 

***Stock-BasedCompensation***

* *

The Companymeasures compensation expense for its stock-based employee compensation plans,which are described in Note 8. Statement of Financial Accounting Standards 123,*Accounting for Stock-Based Compensation*(SFAS 123), encourages, but does not require, companies to record compensationcost for stock-based employee compensation plans based on the fair market valueof options granted. The Company chose to account for stock based compensationusing the intrinsic value method prescribed in APB Opinion No. 25, *Accounting for Stock Issued to Employees*,and related interpretations. Accordingly, compensation expense is recorded tothe extent that the current market price of the underlying stock exceeds theexercise price. On December 31, 2002, the Financial Accounting Standards Board(“FASB”) issued Statement of Financial Accounting Standard 148, *Accounting for Stock Based Compensation - Transitionand Disclosure* (SFAS 148), which amends SFAS 123. SFAS 148 requiresmore prominent and frequent disclosures about the effects of stock-basedcompensation. The Company continued to account for its stock-based compensationaccording to the provisions of APB Opinion No. 25. The pro forma disclosurerequirements prescribed by SFAS 123, as amended by SFAS 148 are included inNote 1 to the Financial Statements.

 

In December2004, FASB issued Statement No. 123-R, *Share-BasedPayment,*which establishes accounting standards for transactions inwhich an entity receives employee services in exchange for (a) equityinstruments of the entity or (b) liabilities that are based on the fair valueof the entity’s equity instruments or that may be settled by the issuance ofequity instruments*.*Effective inthe first quarter of 2006, SFAS 123-R will require us to recognize thegrant-date fair value of stock options and equity based compensation issued toemployees in the statement of operations. The statement also requires that suchtransactions be accounted for using the fair –value-based method, therebyeliminating use of the intrinsic value method of accounting in APB No. 25, *Accounting for Stock Issued to Employees,*whichwas permitted under Statement 123, as originally issued. This change in accountingwill be required in the first quarter of 2006 and will result in increasedcompensation expense for stock options over their vesting period.

 

See note 1 tothe financial statements on page 44 under the heading Stock Options. TheCompany will adopt the fair value method of accounting for stock options duringthe first quarter of 2006.

 

***Researchand Development***

*** ***

Research anddevelopment expenses include all direct costs, primarily salaries for personneland expenditures with external development sources, related to the developmentof new products and significant enhancements to existing products and areexpensed as incurred until such time as technological

 

23

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feasibility isachieved. For the years 2003, 2004 and 2005, we spent approximately $945,000,$728,000 and $870,000 respectively, on research and development. No researchand development expenses were capitalized in 2003, 2004 or 2005 and allpreviously capitalized research and development expenses were fully amortizedat December 31, 2002.

 

***IncomeTaxes***

* *

GlobalSCAPEaccounts for income taxes using the liability method in accordance withStatement of Financial Accounting Standards No. 109, *Accounting for Income Taxes*. The liability method providesthat the deferred tax assets and liabilities are recorded based on thedifference between the tax bases of assets and liabilities and their carryingamount for financial reporting purposes, as measured by the enacted tax ratesand laws that will be in effect when the differences are expected to reverse. Deferredtax assets are carried on the balance sheet with the presumption that they willbe realizable in future periods when pre-tax income is generated. Predictingthe ability to realize these assets in future periods requires a great deal ofjudgment by management. Although we have generated pre-tax income in previousyears, unusual or infrequently occurring transactions resulted in pre-taxlosses in 2001 and 2002 (compensation charges in 2001 and the settlement withATSI and termination of CEO in 2002). Statement of Financial AccountingStandards (SFAS) No. 109 requires a valuation allowance to reduce the deferredtax assets reported if, based on the weight of the evidence, it is more likelythan not that some portion or all of the deferred tax assets will not berealized. After consideration of all of the evidence, both positive andnegative, management determined that a $540,350 valuation allowance at December31, 2003 and $484,853 valuation allowance at December 31, 2004, was necessaryto reduce the deferred tax assets to the amount that will more likely than notbe realized. No allowance was considered necessary at December 31, 2005. Thechange in the valuation allowance for the current year is a net decrease of $484,853.

 

##### **Comparison of Year Ended December 31, 2005 to YearEnded December 31, 2004**

##### ** **

***Revenue.***Wederive our revenues primarily from software sales. Revenue is comprised of thegross selling price of software, including shipping charges and the earned portionof support and maintenance agreements. Revenues increased approximately 39%from 2004 to 2005, from $4,930,660 in 2004 to $6,833,048 in 2005. Unit volumedecreased with approximately 170,000 licenses sold in 2004 versus 124,000 soldin 2005. The decrease in unit volumes was offset by an increase in the averageselling price of our products from $39.66 in 2004 to $58.87 in 2005 as a resultof increased sales of our enhanced file transfer offerings. The increase inrevenues was up quarter over quarter in 2005 compared to the same quarters in2004. We believe the economic uncertainty in the first three quarters of 2004contributed to those periods’ poor performance along with the turnover in oursales force. Our fourth quarter revenues in 2004 increased approximately 11%over the same quarter in 2003 and approximately 56% in the fourth quarter 2005over 2004.

 

In 2004 and2005, approximately 69% and 50%, respectively, of our revenues were generatedfrom sales of CuteFTP and CuteFTP Pro. Combined sales of these productsincreased approximately 1% in revenue year over year. Sales of CuteFTP declinedapproximately 22% while sales of CuteFTP Pro increased approximately 18%. Thosechanges were the result of the continuing maturity of CuteFTP and theincreasing demand by business users of CuteFTP Pro. CuteFTP Pro has morefeatures and is designed for business use, whereas CuteFTP is for home useonly. Users are moving to CuteFTP Pro for the advanced features and securitylevels. Our reliance on these products may negatively impact future resultsfrom operations if we are unable to maintain revenues from these products orsuccessfully introduce new product offerings. The relatively flat salesperformance of CuteFTP and CuteFTP Pro was offset by an increase in sales ofour Secure Server and Enhanced File Transfer products. Sales of these productsgrew from 14% of our revenues in 2004 to 43% in 2005. This increase was theresult of the needs of businesses to transfer files in a secure fashion using businessor enterprise level software. In addition, because of the more complex natureof these products, purchasers require increased maintenance and support. As aresult, our maintenance and support revenues increased by 239% from 2004 to2005 from $217,469 in 2004 to $737,003, net of deferred revenue. Ourmaintenance and support revenues are generally recognized over the life of theagreement, which is discussed further under the Deferred Revenue section ofItem 7.

 

24

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***Cost of Revenues.***Costof revenues consists primarily of royalties, a portion of our bandwidth costsas well as production, packaging and shipping costs for boxed copies ofsoftware products. Cost of revenues decreased by approximately 25% betweenperiods from $371,242 in 2004 to $279,964 in 2005 due to a decrease in royaltyexpenses related to our software distribution agreements with third parties. Royaltiesthat we pay on software products licensed from third parties, which we resell,are expensed as a cost of sales when the software product is sold or earlier ifthe recoverability of any prepaid royalties is in doubt. We expect the cost ofrevenues to remain consistent both as a percentage of sales and in gross termsin 2006 when compared to 2005.

 

***Selling, General andAdministrative.***Selling, general andadministrative expenses consist primarily of personnel and related expenses,marketing, customer support, professional fees, rent, bad debt and credit cardtransaction fees. Selling, general and administrative expenses increased by approximately15%  from $3,456,598 in 2004 to$3,989,372 in 2005. The number of persons employed by GlobalSCAPE was reducedfrom 45 to 36 in February 2004. As of March 1, 2006 the number of employees was41.

 

***Research andDevelopment.***Research and development expensesincreased by approximately 19% from $727,000 in 2004 to $870,000 in 2005. Includedin the research and development expenses, external development costs increasedapproximately 48% from 2004 to 2005. External development was increased inorder to maintain the scheduled releases of CuteFTP, CuteFTP Pro, Secure FTPServer, and EFT.

 

***Depreciation andAmortization.***Depreciation and amortizationexpense consists of depreciation expense related to our fixed assets and theamortization of the trademark associated with our purchase of CuteFTP in 1998. Depreciationand amortization expense declined by $73,763 or approximately 43% year overyear. This decrease was due primarily to a reduction in amortization expense. Thepurchase of CuteFTP was fully amortized as of September 20, 2003. In addition,depreciation expense has declined due to a slowdown in additions to fixedassets in current periods relative to prior periods.

 

***Other Income(Expense), Net.***In 2004, we had interest expenseof $1,651 related primarily to an advance on our line of credit and financingof insurance premiums. In 2005, we had interest expense of $620 relatedprimarily to the financing of insurance premiums. During 2005, we had interestincome of $10,685 as a result of interest earned on excess cash balances. During2005, we had a gain of $1,242 on the sale of fully depreciated fixed assets.

 

***Income Taxes.***Theprovision for state income taxes in 2004 was $1,489 and there was no provisionfor federal income taxes in 2004. GlobalSCAPE’s effective income tax rate was0.7% and differs from the federal rate primarily because of a change in thevaluation allowance for deferred tax assets. The provision for state incometaxes in 2005 was $1,065 and the provision for federal income taxes was $65,546in 2005. GlobalSCAPE’s effective income tax rate is 4.1% and differs from thefederal rate primarily because of a change in the valuation allowance fordeferred tax assets. The Company utilized net operating loss carryforwards in2004 to eliminate its Federal income tax expense and utilized the remaining netoperating loss carryforwards in 2005 to substantially reduce its Federal incometax expense.

 

***Net Income.***In2004, net income was primarily the result of a slight increase in revenue, adecrease in the cost of revenues, SG&A, research and development anddepreciation costs. Significant effort was put in to controlling expenses in2004, including the layoff of 9 employees. In 2005, net income was primarilythe result of the introduction of our Enhanced File Transfer product and thefeatures added to our Secure FTP Server product, resulting in an increase inrevenue, while we continued to control expenses.

 

##### **Comparison of Year Ended December 31, 2004 to YearEnded December 31, 2003**

##### ** **

***Revenue.***Wederive our revenues primarily from software sales. Revenue is comprised of thegross selling price of software, including shipping charges and the earnedportion of support and maintenance agreements. Revenues increased approximately2% from 2003 to 2004, from $4,847,119 in 2003 to $4,930,660 in 2004. Unitvolume was relatively flat with approximately 175,000 sold in 2003

 

25

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versus 170,000in 2004. The increase in revenues was pronounced in the fourth quarter whencompared to the same period in 2003. We believe the economic uncertainty in thefirst three quarters of 2004 contributed to those periods’ poor performancealong with the turnover in our sales force. Our fourth quarter revenues increasedapproximately 11% over the same quarter in 2003.

 

In 2003 and2004, approximately 75% and 69%, respectively, of our revenues were generatedfrom sales of CuteFTP and CuteFTP Pro. Combined sales of these productsdeclined approximately 7% year over year as a result of the changing needs ofindividuals and business to transfer files on the internet. Sales of CuteFTPdeclined approximately 36% while sales of CuteFTP Pro increased approximately41%. The shift in revenue from CuteFTP to CuteFTP Pro was due to additionalfeatures in CuteFTP Pro that businesses and individuals required to securelytransfer files across the internet. Our reliance on these products maynegatively impact future results from operations if we are unable to maintainrevenues from these products or successfully introduce new product offerings. InNovember 2004, GlobalSCAPE introduced its Enhanced File Transfer product tomeet the growing needs of businesses to comply with requirements of businessesto transfer sensitive information securely.

 

***Cost of Revenues.***Costof revenues consists primarily of royalties, a portion of our bandwidth costsas well as production, packaging and shipping costs for boxed copies ofsoftware products. Cost of revenues decreased approximately 30% between periodsfrom $532,910 in 2003 to $371,242 in 2004 due to a decrease in royalty expensesrelated to our software distribution agreements with third parties. Royaltiesthat the Company pays on software products licensed from third parties, whichit resells, are expensed as a cost of sales when the software product is soldor earlier if the recoverability of any prepaid royalties is in doubt. GlobalSCAPEno longer distributes the Protect IIS product and expensed prepaid royalties ofapproximately $15,000 in December 2003. GlobalSCAPE’s agreement with HannonHill Corp. required a minimum royalty of $16,667 per month, as prepayment ofroyalties, for 12 months beginning in December 2002. These payments wereexpensed as paid because the lower than expected sales of PureCMS raised doubtas to the realization of benefit from these prepayments. The total amountexpensed in 2003 relating to these prepayments was $183,337.

 

***Selling, General andAdministrative.***Selling, general andadministrative expenses consist primarily of personnel and related expenses,marketing, customer support, professional fees, rent, bad debt and credit cardtransaction fees. Selling, general and administrative expenses decreasedapproximately 4%  a year from $3,613,759in 2003 to $3,456,598 in 2004 as a result of a decrease in the number ofemployees in 2004. The number of persons employed by GlobalSCAPE was reducedfrom 45 to 36 in February 2004.

 

Forcomparative purposes, selling, general and administrative expenses for 2003includes approximately $540,000 in advertising expenses, relating primarily tothe launch of the PureCMS product, as compared to $205,000 in 2004. Selling,general and administrative expenses also include approximately $134,900 inamortization of the CuteFTP trademark in 2003, when it was fully amortized.

 

***Research andDevelopment.***Research and development expensesdecreased approximately 23% from $945,395 in 2003 to $727,423 due to areduction in the number of employees in 2004 and related salaries, payrolltaxes and benefits costs. External development costs increased approximately11% from 2003 to 2004. External development was increased to offset the loss ofinternal labor due to the layoff in order to maintain the scheduled releases ofCuteFTP, CuteFTP Pro, Secure FTP Server, PureCMS and EFT.

 

***Depreciation andAmortization.***Depreciation and amortizationexpense consists of depreciation expense related to our fixed assets and theamortization of the trademark associated with our purchase of CuteFTP in 1998. Depreciationand amortization expense declined $218,320 or approximately 56% year over year.This decrease was due primarily to a reduction in amortization expense. Thepurchase of CuteFTP was fully amortized as of September 2003. In addition,depreciation expense has declined due to a slowdown in additions to fixedassets in current periods relative to prior periods.

 

***Interest Expense,Net.***In 2003, we had interest expense of $5,016related primarily to capital leases. In 2004, we had interest expense of $1,651related primarily to an advance on our line of credit and financing ofinsurance premiums.

 

26

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***Income Taxes.***Theprovision for state income taxes in 2003 was $1,400 and there was no provisionfor federal income taxes in 2003. GlobalSCAPE’s effective income tax rate wasnegative 0.2% and differs from the federal rate primarily because of a changein the valuation allowance for deferred tax assets. The provision for stateincome taxes in 2004 was $1,489 and there was no provision for federal incometaxes in 2004. GlobalSCAPE’s effective income tax rate is 0.7% and differs fromthe federal rate primarily because of a change in the valuation allowance fordeferred tax assets. The Company utilized its net operating loss carryforwardsin 2004 to reduce its Federal income tax expense.

 

***Net Income.***In2003, the net loss was primarily the result of disappointing revenueperformance in the first and fourth quarters exacerbated by the product launchexpenses related to PureCMS. In 2004, the net income was primarily the resultof a slight increase in revenue, a decrease in the cost of revenues, SG&A,research and development and depreciation costs. Significant effort was put into controlling expenses in 2004, including the layoff of 9 employees.

 

27

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###### **Item7A.**                Quantitativeand Qualitative Disclosures About Market Risk

 

To date, wehave not utilized derivative financial instruments or derivative commodityinstruments. We do not expect to employ these or other strategies to hedgemarket risk in the foreseeable future. We may invest our cash in money marketfunds, which are subject to minimal credit and market risk. We believe that theinterest rate risk and other relevant market risks associated with thesefinancial instruments are immaterial.

 

In 2005approximately 33% of our revenues came from customers outside the United States.All revenues are received in U.S. dollars so we have no exchange rate risk withregard to the sale. However, as of July 1, 2003, the European Union (EU)enacted Value Added Taxes (VAT) on electronic purchases. These taxes arecharged to our non-business customers in the EU and, in our case, are remittedquarterly in pound sterling. We expect that the impact of any currencytranslation involved in the remittance of VAT taxes will not be material to ourbusiness.

 

28

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## **Item 8.**           Financial Statementsand Supplementary Data

## ** **

**GlobalSCAPE, Inc.**

** **

**Index to Consolidated Financial Statements**

 

**Years ending December 31, 2003, 2004 and 2005**

** **

**Contents**

** **

| Report of Independent Registered Public Accounting Firm - Helin,  Donovan,  Trubee & Wilkinson, LLP |   |
|---------------------------------------------------------------------------------------------------------|--------|
| Report of Independent Registered Public Accounting Firm - Ernst &  Young, LLP                       |   |
| Financial Statements                                                                                    |   |
| Consolidated Balance Sheets                                                                             |   |
| Consolidated Statements of Operations                                                                   |   |
| Consolidated Statements of Stockholders’ Equity                                                    |   |
| Consolidated Statements of Cash Flows                                                                   |   |
| Notes to Consolidated Financial Statements                                                              |   |

 

29

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**Reportof Independent Registered Public Accounting Firm**

 

The Board ofDirectors and Shareholders

GlobalSCAPE,Inc.:

 

We have audited the accompanying consolidated balance sheets of GlobalSCAPE, Inc. (the Company) as of December 31, 2004 and 2005, and the related consolidated statements of operations, stockholders’ equity, and cash flows for the years then ended. These consolidated financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits.

 

We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the consolidated financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the consolidated financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.

 

Inour opinion, the consolidated financial statements referred to above presentfairly, in all material respects, the consolidated financial position of GlobalSCAPE,Inc. as of December 31, 2004 and2005, and the results of their operations and their cash flows for the yearsthen ended in conformity with generally accepted accounting principles in theUnited States of America.

 

 

**Helin, Donovan,Trubee & Wilkinson, LLP**

 

 

February 17,2006

Austin,Texas

 

30

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**Reportof Independent Registered Public Accounting Firm**

 

To the Board of Directors

GlobalSCAPE, Inc.

 

We haveaudited the accompanying consolidated statements of operations, stockholders’equity and cash flows of GlobalSCAPE, Inc. for the year ended December 31, 2003.These financial statements are the responsibility of the Company’s management. Ourresponsibility is to express an opinion on these financial statements based onour audit.

 

We conducted our audit inaccordance with the standards of the Public Company Accounting Oversight Board(United States). Those standards require that we plan and perform theaudit to obtain reasonable assurance about whether the financial statements arefree of material misstatement. We were not engaged to perform an audit of the Company’sinternal control over financial reporting. An audit includes consideration ofinternal control over financial reporting as a basis for designing auditprocedures that are appropriate in the circumstances, but not for the purposeof expressing an opinion on the effectiveness of the Company’s internal controlover financial reporting. Accordingly, we express no such opinion. An auditincludes examining, on a test basis, evidence supporting the amounts anddisclosures in the financial statements. An audit also includes assessing theaccounting principles used and significant estimates made by management, aswell as evaluating the overall financial statement presentation. We believethat our audit provided a reasonable basis for our opinion.

 

In ouropinion, the financial statements referred to above present fairly, in allmaterial respects, the results of operations and cash flows of GlobalSCAPE,Inc. for the year ended December 31, 2003 in conformity with accountingprinciples generally accepted in the United States.

 

Ernst& Young LLP

 

San Antonio, Texas

February 27, 2004

 

31

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**GlobalSCAPE, Inc.**

** **

**Consolidated Balance Sheets**

 
| ** **                                                                                                          | ** ** | **December 31,** | ** ** |
|---------------------------------------------------------------------------------------------------------------------|------------|------------------|------------|
| ** **                                                                                                          | ** ** | **2004**         | ** ** | **2005** | ** ** |
| Assets                                                                                                              |       |             |       |   |   |
| Current  assets:                                                                                                    |       |             |       |   |   |
| Cash and cash equivalents                                                                                           |       | $                | 572,959    |   | $ | 2,029,473 |   |
| Accounts receivable (net of allowance for doubtful  accounts of $10,195 and $12,273 in 2004 and 2005, respectively) |       | 148,534          |       | 590,715 |   |
| Prepaid expenses                                                                                                    |       | 91,144           |       | 65,317 |   |
| Total current assets                                                                                                |       | 812,637          |       | 2,685,505 |   |
|                                                                                                                |       |             |       |   |   |
| Property and equipment:                                                                                             |       |             |       |   |   |
| Furniture and fixtures                                                                                              |       | 332,920          |       | 334,063 |   |
| Software                                                                                                            |       | 245,601          |       | 284,621 |   |
| Equipment                                                                                                           |       | 608,718          |       | 604,517 |   |
| Leasehold improvements                                                                                              |       | 167,762          |       | 167,762 |   |
|                                                                                                                |       | 1,355,001        |       | 1,390,963 |   |
| Accumulated depreciation and amortization                                                                           |       | 1,207,663        |       | 1,238,392 |   |
| Net property and equipment                                                                                          |       | 147,338          |       | 152,571 |   |
|                                                                                                                |       |             |       |   |   |
| Other assets:                                                                                                       |       |             |       |   |   |
| Deferred tax asset                                                                                                  |       | —           |       | 51,983 |   |
| Other                                                                                                               |       | 11,882           |       | 11,612 |   |
| Total other assets                                                                                                  |       | 11,882           |       | 63,595 |   |
|                                                                                                                |       |             |       |   |   |
| Total assets                                                                                                        |       | $                | 971,857    |   | $ | 2,901,671 |   |

 

32

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**GlobalSCAPE, Inc.**

** **

**Consolidated Balance Sheets**

 
| ** **                                                                                                                                                                    | ** ** | **December 31,** | ** ** |
|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|-----------------------|------------|
| ** **                                                                                                                                                                    | ** ** | **2004**              | ** ** | **2005** | ** ** |
| Liabilities and Stockholders’ Equity                                                                                                                                     |       |                  |       |   |   |
| Current liabilities:                                                                                                                                                          |       |                  |       |   |   |
| Accounts payable                                                                                                                                                              |       | $                     | 122,117    |   | $ | 91,763 |   |
| Accrued expenses                                                                                                                                                              |       | 170,654               |       | 234,236 |   |
| Federal income tax payable                                                                                                                                                    |       | —                |       | 117,529 |   |
| Deferred revenue                                                                                                                                                              |       | 178,117               |       | 406,145 |   |
| Total current liabilities                                                                                                                                                     |       | 470,888               |       | 849,673 |   |
|                                                                                                                                                                          |       |                  |       |   |   |
| Long-term liabilities:                                                                                                                                                        |       |                  |       |   |   |
| Deferred compensation                                                                                                                                                         |       | —                |       | 12,121 |   |
| Other long-term liabilities                                                                                                                                                   |       | 28,038                |       | 16,824 |   |
| Total long-term liabilities                                                                                                                                                   |       | 28,038                |       | 28,945 |   |
|                                                                                                                                                                          |       |                  |       |   |   |
| Total Liabilities                                                                                                                                                             |       | 498,926               |       | 878,618 |   |
|                                                                                                                                                                          |       |                  |       |   |   |
| Commitments and contingencies                                                                                                                                                 |       |                  |       |   |   |
|                                                                                                                                                                          |       |                  |       |   |   |
| Stockholders’ equity:                                                                                                                                                    |       |                  |       |   |   |
| Preferred stock, par value $0.001 per  share, 10,000,000 authorized, no shares issued or outstanding                                                                          |       | —                |       | — |   |
| Common stock, par value $0.001 per share, 40,000,000  shares authorized, 13,773,219 and 13,798,119 shares issued and Outstanding at  December 31, 2004 and 2005, respectively |       | 13,773                |       | 13,797 |   |
| Additional paid-in capital                                                                                                                                                    |       | 675,365               |       | 684,281 |   |
| Retained earnings (deficit)                                                                                                                                                   |       | (216,207              | )          | 1,324,975 |   |
| Total stockholders’ equity                                                                                                                                               |       | 472,931               |       | 2,023,053 |   |
| Total liabilities and stockholders’ equity                                                                                                                               |       | $                     | 971,857    |   | $ | 2,901,671 |   |

 

See accompanying notes.

 

33

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**GlobalSCAPE, Inc.**

** **

**Consolidated Statements ofOperations**

 
| ** **                                                                            | ** ** | **For the Years ended December 31,** | ** ** |
|---------------------------------------------------------------------------------------|------------|---------------------------------------------------------------|------------|
| ** **                                                                            | ** ** | **2003**                                                      | ** ** | **2004** | ** ** | **2005** | ** ** |
| Operating revenues:                                                                   |       |                                                          |       |   |   |   |   |
| Software product revenues                                                             |       | $                                                             | 4,734,105  |   | $ | 4,713,191 |   | $ | 6,096,045 |   |
| Maintenance and support (net of deferred  revenues)                                   |       | 113,014                                                       |       | 217,469 |   | 737,003 |   |
| Total revenues                                                                        |       | 4,847,119                                                     |       | 4,930,660 |   | 6,833,048 |   |
|                                                                                  |       |                                                          |       |   |   |   |   |
| Operating expenses:                                                                   |       |                                                          |       |   |   |   |   |
| Cost of revenues (exclusive of depreciation  and amortization shown separately below) |       | 532,910                                                       |       | 371,242 |   | 279,964 |   |
| Selling, general and administrative Expenses                                          |       | 3,613,759                                                     |       | 3,456,598 |   | 3,989,372 |   |
| Research and development expenses                                                     |       | 945,395                                                       |       | 727,423 |   | 869,155 |   |
| Depreciation and amortization                                                         |       | 390,154                                                       |       | 171,834 |   | 98,071 |   |
| Total operating expense                                                               |       | 5,482,218                                                     |       | 4,727,097 |   | 5,236,562 |   |
| Income  (loss) from operations                                                        |       | (635,099                                                      | )          | 203,563 |   | 1,596,486 |   |
|                                                                                  |       |                                                          |       |   |   |   |   |
| Other income (expense):                                                               |       |                                                          |       |   |   |   |   |
| Interest expense                                                                      |       | (5,016                                                        | )          | (1,651 | ) | (620 | ) |
| Interest income                                                                       |       | —                                                        |       | — |   | 10,685 |   |
| Gain (loss) on sale of assets                                                         |       | (1,486                                                        | )          | — |   | 1,242 |   |
| Total other income (expense)                                                          |       | (6,502                                                        | )          | (1,651 | ) | 11,307 |   |
| Income (loss) before income taxes                                                     |       | (641,601                                                      | )          | 201,912 |   | 1,607,793 |   |
|                                                                                  |       |                                                          |       |   |   |   |   |
| Income tax provision:                                                                 |       |                                                          |       |   |   |   |   |
| Current:                                                                              |       |                                                          |       |   |   |   |   |
| Federal                                                                               |       | —                                                        |       | — |   | 117,529 |   |
| State                                                                                 |       | 1,400                                                         |       | 1,489 |   | 1,065 |   |
| Deferred:                                                                             |       |                                                          |       |   |   |   |   |
| Federal (benefit)                                                                     |       | —                                                        |       | — |   | (51,983 | ) |
| State                                                                                 |       | —                                                        |       | — |   | — |   |
| Total income tax provision                                                            |       | 1,400                                                         |       | 1,489 |   | 66,611 |   |
|                                                                                  |       |                                                          |       |   |   |   |   |
| Net income (loss)                                                                     |       | $                                                             | (643,001   | ) | $ | 200,423 |   | $ | 1,541,182 |   |
|                                                                                  |       |                                                          |       |   |   |   |   |
| Net income (loss) per common share – basic                                       |       | $                                                             | (0.05      | ) | $ | 0.01 |   | $ | 0.11 |   |
| Net income (loss) per common share -  assuming dilution                               |       | $                                                             | (0.05      | ) | $ | 0.01 |   | $ | 0.10 |   |
|                                                                                  |       |                                                          |       |   |   |   |   |
| Weighted average shares outstanding- basic                                            |       | 13,361,706                                                    |       | 13,668,800 |   | 13,778,989 |   |
| Weighted average shares outstanding- assuming  dilution                               |       | 13,361,706                                                    |       | 14,262,796 |   | 15,442,524 |   |

 

See accompanying notes.

 

34

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**GlobalSCAPE, Inc.**

** **

**Consolidated Statements ofStockholders’ Equity**

** **
| ** **                    | ** ** | **Common Stock** | ** ** | **Additional paid in** | ** ** | **Retained  Earnings** | ** ** | ** **    | ** ** |
|-------------------------------|------------|-----------------------|------------|----------------------------------|------------|------------------------|------------|---------------|------------|
| ** **                    | ** ** | **Shares**            | ** ** | **Amount**                       | ** ** | **Capital**            | ** ** | **(Deficit)** | ** ** | **Total** | ** ** |
| Balances at December 31, 2002 |       | 13,358,619            |       | $                                | 13,359     |                   | $          | 670,307       |       | $ | 226,371 |   | $ | 910,037 |   |
| Net loss                      |       | —                |       | —                           |       | —                 |       | (643,001      | )          | (643,001 | ) |
| Exercise of options           |       | 130,000               |       | 130                              |       | 1,586                  |       | —        |       | 1,716 |   |
| Balances at December 31, 2003 |       | 13,488,619            |       | 13,489                           |       | 671,893                |       | (416,630      | )          | 268,752 |   |
| Net income                    |       | —                |       | —                           |       | —                 |       | 200,423       |       | 200,423 |   |
| Exercise of options           |       | 284,600               |       | 284                              |       | 3,472                  |       | —        |       | 3,756 |   |
| Balances at December 31, 2004 |       | 13,773,219            |       | 13,773                           |       | 675,365                |       | (216,207      | )          | 472,931 |   |
| Net income                    |       | —                |       | —                           |       | —                 |       | 1,541,182     |       | 1,541,182 |   |
| Exercise of Options           |       | 24,900                |       | 24                               |       | 8,916                  |       | —        |       | 8,940 |   |
| Balance at December 31, 2005  |       | 13,798,119            |       | $                                | 13,797     |                   | $          | 684,281       |       | $ | 1,324,975 |   | $ | 2,023,053 |   |

 

See accompanying notes.

 

35

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**GlobalSCAPE, Inc.**

** **

**Consolidated Statements of CashFlows**

** **
| ** **                                                                                        | ** ** | **For the Years ended December 31,** | ** ** |
|---------------------------------------------------------------------------------------------------|------------|-------------------------------------------|------------|
| ** **                                                                                        | ** ** | **2003**                                  | ** ** | **2004** | ** ** | **2005** | ** ** |
| Operating  Activities:                                                                            |       |                                      |       |   |   |   |   |
| Net income  (loss)                                                                                |       | $                                         | (643,001   | ) | $ | 200,423 |   | $ | 1,541,182 |   |
| Adjustments  to reconcile net income (loss) to net cash provided (used) by operating  activities: |       |                                      |       |   |   |   |   |
| Bad debt  expense (recovery), net                                                                 |       | 14,508                                    |       | (17,087 | ) | 8,231 |   |
| Depreciation  and amortization                                                                    |       | 390,154                                   |       | 171,833 |   | 98,071 |   |
| Loss (gain)  on disposition of assets                                                             |       | 1,486                                     |       | — |   | (1,242 | ) |
| Deferred  taxes                                                                                   |       | —                                    |       | — |   | (51,983 | ) |
| Changes in  operating assets and liabilities:                                                     |       |                                      |       |   |   |   |   |
| Accounts  receivable                                                                              |       | (3,354                                    | )          | 109,167 |   | (450,413 | ) |
| Prepaid  expenses                                                                                 |       | 25,821                                    |       | (44,716 | ) | 25,828 |   |
| Other assets                                                                                      |       | —                                    |       | — |   | 269 |   |
| Accounts  payable                                                                                 |       | 55,660                                    |       | (58,438 | ) | (30,353 | ) |
| Accrued  expenses                                                                                 |       | 65,440                                    |       | (3,281 | ) | 63,583 |   |
| Federal  income tax payable                                                                       |       | —                                    |       | — |   | 117,529 |   |
| Deferred  revenue                                                                                 |       | (1,047                                    | )          | 37,628 |   | 228,028 |   |
| Other  long-term liabilities                                                                      |       | (11,215                                   | )          | (11,215 | ) | 906 |   |
| Net cash  provided (used) by operating activities                                                 |       | (105,548                                  | )          | 384,314 |   | 1,549,636 |   |
| Investing  Activities:                                                                            |       |                                      |       |   |   |   |   |
| Proceeds  from sale of property and equipment                                                     |       | —                                    |       | — |   | 1,242 |   |
| Purchase of  property and equipment                                                               |       | (73,027                                   | )          | (42,250 | ) | (103,304 | ) |
| Net cash  used in investing activities                                                            |       | (73,027                                   | )          | (42,250 | ) | (102,062 | ) |
| Financing  Activities:                                                                            |       |                                      |       |   |   |   |   |
| Issuance of  common stock                                                                         |       | 1,716                                     |       | 3,756 |   | 8,940 |   |
| Borrowings  under notes payable                                                                   |       | 100,000                                   |       | — |   | — |   |
| Principal  payments on notes payable                                                              |       | —                                    |       | (100,000 | ) | — |   |
| Principal  payments on capital lease obligations                                                  |       | (61,317                                   | )          | (15,294 | ) | — |   |
| Net cash  provided (used) in financing activities                                                 |       | 40,399                                    |       | (111,538 | ) | 8,940 |   |
| Net increase  (decrease) in cash and cash equivalents                                             |       | (138,176                                  | )          | 230,526 |   | 1,456,514 |   |
| Cash at  beginning of period                                                                      |       | 480,609                                   |       | 342,433 |   | 572,959 |   |
| Cash at end  of period                                                                            |       | $                                         | 342,433    |   | $ | 572,959 |   | $ | 2,029,473 |   |

 

See accompanying notes.

 

36

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** **
| ** **                                         | ** ** | **For the Years ended December 31,** | ** ** |
|----------------------------------------------------|------------|-------------------------------------------|------------|
| ** **                                         | ** ** | **2003**                                  | ** ** | **2004** | ** ** | **2005** | ** ** |
| Supplemental disclosure of cash flow  information: |       |                                      |       |   |   |   |   |
| Cash paid during the year for:                     |       |                                      |       |   |   |   |   |
| Interest                                           |       | $                                         | 4,852      |   | $ | 1,651 |   | $ | 620 |   |
| Income taxes  paid                                 |       | $                                         | 1,400      |   | $ | 1,489 |   | $ | 1,065 |   |

 

Seeaccompanying notes.

 

37

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### **GlobalSCAPE, Inc.**

### **Notes to Consolidated Financial Statements**

### **December 31, 2004 and 2005**

###  

**1.**                                      Overviewof the Business and Significant Accounting Policies

 

***Corporate Structure***

*** ***

All of the Company’s operations are conducted by GlobalSCAPE Texas, LP,a Texas limited partnership. The partners of GlobalSCAPE Texas, LP are twoNevada limited liability companies, which are both wholly owned subsidiaries ofGlobalSCAPE, Inc., a Delaware corporation. GlobalSCAPE, Inc. wasapproximately 70% owned by the Brown and Mann-GlobalSCAPE Joint Venture, withthe remainder held publicly. In October 2004, the Brown andMann-GlobalSCAPE Joint Venture began distribution of its GlobalSCAPE stock toits two partners in their respective percentages. Prior to December 31,2005, the partnership had completed its distribution. GlobalSCAPE, Inc. isa holding company and conducts no operations. The stock of GlobalSCAPE, Inc.is quoted on the OTC Bulletin Board. References to “GlobalSCAPE” or the “Company”refer collectively to all of these entities unless otherwise indicated.

 

***Natureof Business***

* *

GlobalSCAPE, founded in April 1996, develops and distributesInternet related software. The Company is best known for its popular filetransfer program, CuteFTP. Sales of CuteFTP and CuteFTP Pro accounted for 69%and 50% of total revenues in 2004 and 2005, respectively. Secure FTP Serveraccounted for approximately 14% of total revenues in 2004 and 22% in 2005,increasing from 7% of total revenues in 2003. The Company derives its revenuesprimarily from sales of licenses to use its software products. The Company isorganized and operates as one operating segment, the provision ofInternet-based software, which it markets over the Internet and through itsdirect internal sales force.

 

***Basisof Presentation***

* *

The preparation of financial statements in conformity with accountingprinciples generally accepted in the Unites States requires management to makeestimates and assumptions that affect the amounts reported in the financialstatements and accompanying notes. Actual results could differ from thoseestimates.

 

***Principlesof Consolidation***

* *

The consolidated financial statements include all subsidiaries. Allinter-company transactions and balances have been eliminated.

 

***Liquidity***

* *

The Company incurred significant operating losses during 2001, 2002 and2003 and continued, in January, February and March of 2004, to incursignificant operating losses. In February 2004 GlobalSCAPE reduced itsworkforce by 20%, laying off 9 of the 45 people then employed by the Company.

 

The Company is highly dependent on the sale of two software products,CuteFTP and CuteFTP Pro, which are subject to technological and competitiveobsolescence. Sales from these two products, which represented 50% of theCompany’s revenues in 2005, increased 1% in revenue from the previous year. Thisincrease was primarily in sales of CuteFTP Pro, which increased 18%. Sales ofCuteFTP decreased 22% year over year and sales of Secure FTP Server, thecompanion product to CuteFTP Pro, increased 119%. Secure FTP Server accountedfor approximately 14% and 22% in 2004 and 2005 respectively of total revenues. Substantiallyall software products ultimately reach a point in their lifecycle in whichsales can be expected to plateau or decline. While it cannot be determined withcertainty, CuteFTP may have reached such a point in its lifecycle. Managementbelieves that the market for stand-alone FTP clients for home consumers may bedeclining. However, we have not seen the same decline in

 

38

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the market for secure FTP clients and serverssuch as CuteFTP Pro and Secure Server which we believe better target the needsof businesses.

 

The Company’s liquidity could be reduced in 2006 if sales of CuteFTPcontinue to decline and the Company is unable to successfully introduce newproducts or increase sales of existing products.

 

If sales decline or the Company’s liquidity otherwise requires,management has the intent and ability to reduce personnel and personnel-relatedcosts, reduce or substantially eliminate capital expenditures and/or reduce orsubstantially eliminate research and development expenditures.

 

***RevenueRecognition***

* *

The Company recognizes revenue in accordance with the AmericanInstitute of Certified Public Accountants Statement of Position (“SOP”) 97-2, *Software Revenue Recognition*, as modifiedby SOP 98-9, *Modification of SOP 97-2,Software Revenue Recognition, With Respect to Certain Transactions*.

 

Revenues from the sale of software products are recognized andcompletely earned upon shipment or electronic delivery of the product providedthat persuasive evidence of an arrangement exists, collection is probable,payment terms are fixed and determinable and no significant obligations remain.

 

The Company also sells technical support and maintenance agreements(post contract customer support “PCS”), which are sometimes bundled with thesoftware. When vendor specific objective evidence (“VSOE”) of fair valueexists for all elements in a multiple element arrangement, revenue is allocatedto each element based on the relative fair value of each of the elements. VSOEof fair value is established by the price charged when the same element is soldseparately. In a multiple element arrangement whereby VSOE of fair value of allundelivered elements exists but VSOE of fair value does not exist for one ormore delivered elements, revenue is recognized using the residual method. Underthe residual method, the fair value of the undelivered elements is deferred andthe remaining portion of the arrangement fee is recognized as revenue, assumingcollection is probable. Revenue allocated to PCS is recognized ratably over thecontractual term, typically one year.

 

The Company began selling technical support and maintenance servicesfor some of its software products in 2001. In 2004 and 2005, sales ofenterprise class products resulted in higher maintenance and supportagreements sold to customers and as a result deferred revenue at December 31,2005 was $406,145.

 

The outbound shipping charges charged to the customer are included insoftware product revenues and amounted to approximately $58,000, $38,000 and$18,000 in 2003, 2004 and 2005, respectively. The costs associated with theseshipping charges are included in the software products cost of revenue.

 

***RoyaltyCosts***

* *

Royalties that the Company pays on software products licensed fromthird parties, which it resells, are expensed as a cost of sales when thesoftware product is sold or earlier if the recoverability of any prepaidroyalties is in doubt. The Company has distribution agreements with Hannon HillCorp., Trellix Corp., Perseus Development Corp., Beehive Software, Inc.,Visicom Media, Inc., and Glueck and Kanja. The GlobalSCAPE softwareproducts associated with each of the companies are PublishXML, CuteSITEBuilder, Web Survey, Mac FTP, CuteHTML Pro and Enhanced File Transfer (EFT),respectively. GlobalSCAPE’s agreement with Hannon Hill Corp. required a minimumroyalty of $16,667 per month, as prepayment of royalties, for 12 monthsbeginning in December 2002. These payments were expensed as paid becausethe lower than expected sales of PureCMS raised doubt as to the realization ofbenefit from these prepayments. The total amount expensed in 2003 relating tothese prepayments was $183,337. The Company accrued approximately $36,000, $11,000,and $10,000 in royalty expense in 2003, 2004 and 2005, respectively.

 

39

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***Concentrationsof Credit Risk and Significant Customers***

* *

Financial instruments that potentially subject the Company to concentrationsof credit risk consist principally of cash and cash equivalents, and accountsreceivable. Cashis deposited in demand accounts in federally insured domestic institutions tominimize risk. The Company provides credit, in the normal course ofbusiness, to a number of companies and performs ongoing evaluations of itscredit risk. The Company requires no collateral from its customers. Managementestimates the allowance for uncollectible accounts based on their historicalexperience and credit evaluation. No single customer accounted for more than 2%of revenues in 2003 or 2004. One customer accounted for approximately 2.6% ofrevenues in 2005.

 

Cashand cash equivalents, accounts receivable, employee advances, accounts payable,accrued expenses and notes payable, related party are reflected in theaccompanying financial statements at cost, which approximates fair valuebecause of the short term maturity of these instruments.

 

***OtherConcentrations***

* *

*Sales in Foreign Markets.*In2003, 2004 and 2005, approximately 35%, 36% and 33%, respectively, of theCompany’s revenues were generated from sales to customers who providedaddresses in foreign countries. However, all revenues are received in U.S.dollars so there is no exchange rate risk with respect to the sale of ourproducts. These sales were concentrated mostly in Western Europe, Canada, andAustralia. In 2003, 2004 and 2005, the UK accounted for approximately 11.1%,10.9% and 9.25%, respectively, of total revenues.

 

*Labor.*GlobalSCAPEutilizes offshore developers for a large portion of the coding phase ofsoftware development. If GlobalSCAPE were unable to continue using thesedevelopers because of political or economic instability, GlobalSCAPE may havedifficulty finding comparably skilled developers or may have to payconsiderably more for the same work, which would have a material adverse impacton results of operations.

 

***AdvertisingCosts***

* *

The Company expenses advertising costs as incurred. Advertisingexpenses charged to operations for the years ended December 31, 2003, 2004and 2005 were approximately $542,000, $205,000 and $300,000, respectively, andare included in selling, general and administrative expenses. The advertisingexpenses in 2003 relate primarily to the PureCMS product launch. In 2004 and2005, the Company incurred advertising cost principally for the purchase ofkeywords for internet searches, a direct mail campaign for EFT, trade showparticipation and advertising in various publications.

 

***IncomeTaxes***

* *

The Company accounts for income taxes using the liability method inaccordance with Statement of Financial Accounting Standards No. 109, *Accounting for Income Taxes*. The liabilitymethod provides that the deferred tax assets and liabilities are recorded basedon the difference between the tax bases of assets and liabilities and theircarrying amount for financial reporting purposes, as measured by the enactedtax rates and laws that will be in effect when the differences are expected toreverse. Deferred tax assets are carried on the balance sheet with thepresumption that they will be realizable in future periods when pre-tax incomeis generated. GlobalSCAPE recorded a deferred tax asset of $51,983 at December 31,2005 as a result of its taxable income for the year. Statement ofFinancial Accounting Standards (SFAS) No. 109 requires a valuationallowance to reduce the deferred tax assets reported if, based on the weight ofthe evidence, it is more likely than not that some portion or all of thedeferred tax assets will not be realized. After consideration of all of theevidence, both positive and negative, management determined that a valuationallowance was necessary at December 31, 2004. No valuation was considerednecessary at December 31, 2005. During 2005 a decrease in the valuationallowance of $484,853 at was necessary to

 

40

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decrease the valuation allowance for the benefit of the net operatingloss carryforward benefit utilized in the current year.

 

***Researchand Development***

* *

Research and development expenses include all direct costs, primarilysalaries for personnel and expenditures with external development sources,related to the development of new products and significant enhancements toexisting products and are expensed as incurred until such time as technologicalfeasibility is achieved. For the years 2003, 2004 and 2005, we spentapproximately $945,000, $728,000 and $870,000, respectively, on research anddevelopment. Typically technological feasibility is achieved very late in the developmentcycle and as such no research and development expenses were capitalized in2003, 2004 or 2005 and all previously capitalized research and developmentexpenses were fully amortized at December 31, 2002.

 

***Stock-BasedCompensation***

* *

Statement of Financial Accounting Standards 123, *Accounting for Stock-Based Compensation*(SFAS 123), encourages, but does not require, companies to record compensationcost for stock-based employee compensation plans based on the fair market valueof options granted. The Company chose to account for stock based compensationusing the intrinsic value method prescribed in APB Opinion No. 25, *Accounting for Stock Issued to Employees*,and related interpretations. Accordingly, compensation expense is recorded tothe extent that the current market price of the underlying stock exceeds theexercise price. On December 31, 2002, the Financial Accounting StandardsBoard (“FASB”) issued Statement of Financial Accounting Standard 148, *Accounting for Stock Based Compensation - Transitionand Disclosure* (SFAS 148), which amends SFAS 123. SFAS 148 requiresmore prominent and frequent disclosures about the effects of stock-basedcompensation. The Company has continued to account for its stock-basedcompensation using the intrinsic value method according to the provisions ofAPB Opinion No. 25.

 

Pro forma information regarding net income and earnings per share isrequired by Statement 148, which also requires that the information bedetermined as if the Company had accounted for its stock options grantedsubsequent to December 31, 1994 under the fair value method of thatStatement. The fair value of these options was estimated at the date of grantusing a Black-Scholes option-pricing model.

 

For purposes of pro forma disclosures, the estimated fair value of theoptions at the grant date is amortized to expense over the options’ estimatedvesting period. The Company’s pro forma information for 2003, 2004 and 2005follows:

 
| ** **                                                                                                                                                                                         | ** ** | **Years ended December 31,** | ** ** |
|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|-----------------------------------|------------|
| ** **                                                                                                                                                                                         | ** ** | **2003**                          | ** ** | **2004** | ** ** | **2005** | ** ** |
| Net income  (loss), as reported                                                                                                                                                                    |       | $                                 | (643,001   | ) | $ | 200,423 |   | $ | 1,541,182 |   |
| Stock based compensation included in the  determination of net income (loss) as reported, net of related tax effects                                                                               |       | —                            |       | — |   | — |   |
| Stock-based  compensation expense that would have been included in the determination of  net income (loss) had the fair value based method been applied to all awards,  net of related tax effects |       | (48,057                           | )          | (19,639 | ) | (25,921 | ) |
| Pro forma  net income (loss)                                                                                                                                                                       |       | $                                 | (691,058   | ) | $ | 180,784 |   | $ | 1,515,261 |   |
|                                                                                                                                                                                               |       |                              |       |   |   |   |   |
| Earnings  (loss) per share:                                                                                                                                                                        |       |                              |       |   |   |   |   |
| Basic- as  reported                                                                                                                                                                                |       | $                                 | (0.05      | ) | $ | 0.01 |   | $ | 0.11 |   |
| Basic- pro  forma                                                                                                                                                                                  |       | $                                 | (0.05      | ) | $ | 0.00 |   | $ | 0.11 |   |
|                                                                                                                                                                                               |       |                              |       |   |   |   |   |
| Diluted- as  reported                                                                                                                                                                              |       | $                                 | (0.05      | ) | $ | 0.01 |   | $ | 0.10 |   |
| Diluted- pro  forma                                                                                                                                                                                |       | $                                 | (0.05      | ) | $ | 0.00 |   | $ | 0.10 |   |
|                                                                                                                                                                                                    |            |                                   |            |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

41

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The weighted average fair value of the individual stock options grantedduring 2003, 2004, and 2005 is estimated at $0.20, $0.11 and $0.31,respectively, on the date of grant. The fair values were determined using aminimum value options-pricing model with the following assumptions:

 

| ** **               | ** ** | **2003** | ** ** | **2004** | ** ** | **2005** | ** ** |
|--------------------------|------------|----------|------------|----------|------------|----------|------------|
| Dividend  yield          |       | None     |       | None     |       | None     |       |
| Expected  volatility     |       | 2.23     |       | 1.64     |       | 1.91     |       |
| Risk-free  interest rate |       | 3.21     | %          | 4.24     | %          | 4.35     | %          |
| Expected  life           |       | 5.0      |       | 5.0      |       | 5.0      |       |

 

***Cashand cash equivalents***

* *

Cash includes all cash and highly liquid investments with originalmaturities of three months or less.

 

***Propertyand Equipment***

* *

Property and equipment is comprised of furniture and fixtures,software, computer equipment and leasehold improvements which are recorded atcost and depreciated using the straight-line method over their estimated usefullives. Expenditures for maintenance and repairs are charged to operations asincurred. Property and equipment acquired under capital leases are depreciatedover their useful lives or the respective lease term, if shorter. Depreciationperiods used for property and equipment range from three to five years.

 

Leasehold improvements are depreciated over the shorter of the leaseterm or the estimated useful life of the asset.

 

***Sale /Disposal of Assets***

* *

During 2005, the Company disposed of equipment and software with anoriginal purchase price of $29,949 and accumulated depreciation of $29,949. GlobalSCAPErecognized a gain of $1,242 related to the disposal of these assets. During2004 the Company disposed of equipment and software with an original purchaseprice of $31,494 and accumulated depreciation of $31,494. GlobalSCAPErecognized no gain or loss related to the disposal of these assets. During 2003the Company disposed of equipment and software with an original purchase priceof $69,738 and accumulated depreciation of $68,252. GlobalSCAPE recognized aloss of $1,486 related to the disposal of these assets.

 

***CapitalizedSoftware Development Costs***

* *

Capitalization of software development costs begins upon theestablishment of technological feasibility and ceases when the product isavailable for general release. The establishment of technological feasibilityand the ongoing assessment of recoverability of capitalized software developmentcosts require considerable judgment by management concerning certain externalfactors including, but not limited to, technological feasibility, anticipatedfuture gross revenue, estimated economic life and changes in software andhardware technologies. These software development costs were amortized usingthe straight-line method over a three-year period and are only those costsincurred in the development of products that are sold to external customers andnot used for internal purposes. No research and development expenses werecapitalized in 2003, 2004 or 2005 and all previously capitalized research anddevelopment expenses were fully amortized at December 31, 2002. Thesesoftware development costs are not related to those costs 

 

42

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incurred for the acquisition of softwareproducts or titles. For the years 2003, 2004 and 2005, we spent approximately$945,000, $728,000 and $870,000, respectively, on research and development.

 

***OtherLong-Term Assets***

* *

Costs incurred for the acquisition of CuteFTP were capitalized andamortized over the estimated useful life of five years using the straight-linemethod. The Core Software Technology on the balance sheet represents thepurchase of the source code and related trademark for CuteFTP and the relatedamortization of these costs. GlobalSCAPE recognized amortization expenserelated to CuteFTP of approximately $135,000 in 2003. The asset was fullyamortized at December 31, 2003.

 

Other assets include deposits for facilities, which are anticipated tobe refunded to the Company upon termination of the lease.

 

***DeferredCompensation***

* *

*The deferred compensationliability is related to an employment agreement with the President. Thedeferred compensation is subject to certain terms and conditions related to hisplanned retirement in December 2008.*

* *

***OtherLong-Term Liabilities***

* *

Other long-term liabilities relate to deferred payments of rent expense.The total amount of base lease payments is being charged to expense onthe straight-line method over the term of the lease.

 

***EarningsPer Common Share***

* *

Basic and diluted net income per common share is presented inconformity with Statement of Financial Accounting Standards No. 128, *Earnings Per Share* (SFAS 128) for allperiods presented. Basic earnings per share is based on the weighted effect ofall common shares issued and outstanding, and is calculated by dividing netincome (loss) available to common stockholders by the weighted average sharesoutstanding during the period. Diluted earnings per share is calculated bydividing net income (loss) available to common stockholders by the weightedaverage number of common shares used in the basic earnings per sharecalculation plus the number of common shares that would be issued assumingconversion of all potentially dilutive common shares outstanding. Below is areconciliation of the numerators and denominators of basic and diluted earningsper share for each of the following years:

 
| ** **                                                    | ** ** | **Year ended December 31,** | ** ** |
|---------------------------------------------------------------|------------|----------------------------------|------------|
| ** **                                                    | ** ** | **2003 (1)**                     | ** ** | **2004 (2)** | ** ** | **2005 (3)** | ** ** |
| **Numerators**                                                |       |                             |       |   |   |   |   |
| Numerator  for basic and diluted earnings per share:          |       |                             |       |   |   |   |   |
| Net income  (loss)                                            |       | $                                | (643,001   | ) | $ | 200,423 |   | $ | 1,541,182 |   |
| **Denominators**                                              |       |                             |       |   |   |   |   |
| Denominators  for basic earnings per share:                   |       |                             |       |   |   |   |   |
| Weighed  average shares outstanding-Basic                     |       | 13,361,706                       |       | 13,668,800 |   | 13,778,989 |   |
| **Dilutive  potential common shares:**                        |       |                             |       |   |   |   |   |
| Stock  Options                                                |       | —                           |       | 593,996 |   | 1,663,535 |   |
| Denominator  for dilutive earnings per share                  |       | 13,361,706                       |       | 14,262,796 |   | 15,442,524 |   |
| Net income  (loss) per common share                           |       | $                                | (0.05      | ) | $ | 0.01 |   | $ | 0.11 |   |
| Net income  (loss) per commons share – assuming dilution |       | $                                | (0.05      | ) | $ | 0.01 |   | $ | 0.10 |   |

 

43

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*(1)*          For the year ended December 31,2003, 1,856,171 options have not been included in dilutive shares as the effectwould be anti-dilutive.

* *

*(2)*          For the year ended December 31,2004, 882,000 options have not been included in dilutive shares as the effectwould be anti-dilutive.

* *

*(3)*          For the year ended December 31,2005, all options have been included in dilutive shares.

* *

*Recent AccountingPronouncements*

* *

Effective July 1, 2005, the Company adopted SFAS No. 153,Exchanges of Nonmonetary Assets, an amendment of Accounting Principles Board (“APB”)Opinion No. 29 (“SFAS 153”). SFAS 153 amended prior guidance to eliminatethe exception for nonmonetary exchanges of similar productive assets andreplaced it with a general exception for exchanges of nonmonetary assets thatdo not have commercial substance. A nonmonetary exchange has commercialsubstance if the future cash flows of the entity are expected to changesignificantly as a result of the exchange. The provisions of SFAS 153 wererequired to be applied prospectively. SFAS 153 did not have a material impacton the Company’s unaudited interim condensed consolidated financial statements.

 

In June 2005, the EITF reached consensus on Issue No. 04-5,Determining Whether a General Partner, or the General Partners as a Group,Controls a Limited Partnership or Similar Entity When the Limited Partners HaveCertain Rights (“EITF 04-5”). EITF 04-5 provides a framework for determiningwhether a general partner controls and should consolidate a limited partnershipor a similar entity in light of certain rights held by the limited partners. Theconsensus also provides additional guidance on substantive rights. EITF 04-5was effective after June 29, 2005 for all newly formed partnerships andfor any pre-existing limited partnerships that modified their partnershipagreements after that date. The adoption of this provision of EITF 04-5 did nothave a material impact on the Company’s unaudited interim condensedconsolidated financial statements. EITF 04-5 must be adopted by January 1,2006 for all other limited partnerships through a cumulative effect of a changein accounting principle recorded in opening equity or it may be appliedretrospectively by adjusting prior period financial statements. The adoption ofthis provision of EITF 04-5 is not expected to have a material impact on theCompany’s unaudited interim condensed consolidated financial statements.

 

In May 2005, the FASB issued SFAS No. 154, Accounting Changesand Error Corrections, a replacement of APB Opinion No. 20 and FASBStatement No. 3 (“SFAS 154”). The statement requires retrospective applicationto prior periods’ financial statements for a voluntary change in accountingprinciple unless it is deemed impracticable. It also requires that a change inthe method of depreciation, amortization, or depletion for long-lived,non-financial assets be accounted for as a change in accounting estimate ratherthan a change in accounting principle. SFAS 154 is effective for accountingchanges and corrections of errors made in fiscal years beginning after December 15,2005. SFAS 154 is not expected to have a material impact on the Company’sunaudited interim condensed consolidated financial statements.

 

In December 2004, the FASB issued SFAS 123 (revised 2004)Share-Based Payment (“SFAS 123(r)”), which revised SFAS No. 123,Accounting for Stock-Based Compensation and supersedes APB Opinion No. 25,Accounting for Stock Issued to Employees. SFAS 123(r) provides additionalguidance on

 

44

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determining whether certain financialinstruments awarded in share-based payment transactions are liabilities. SFAS123(r) also requires that the cost of all share-based transactions be measuredat fair value and recognized over the period during which an employee isrequired to provide service in exchange for an award. The SEC issued a finalruling in April 2005 allowing a public company that is not a smallbusiness issuer to implement SFAS 123(r) at the beginning of the next fiscalyear after June 15, 2005. Thus, the revised pronouncement must be adoptedby the Company by January 1, 2006. As permitted under SFAS 148, Accountingfor Stock-Based Compensation — Transition and Disclosure — an amendment of FASBStatement No. 123, the Company elected to use the prospective method ofaccounting for stock options granted subsequent to December 31, 2002. Optionsgranted prior to January 1, 2003 will continue to be accounted for underthe intrinsic value method until the adoption of SFAS 123(r). In addition, thepro forma impact of accounting for these options at fair value will continue tobe accounted for under the intrinsic value method until the last of thoseoptions vest in 2005. The adoption of SFAS 123(r)® is expected toincrease compensation expense during period that employees vest in their stockoptions.

 

**2.**                                      AccountsReceivable

 

Accounts receivable, which are primarily from sales of softwarelicenses, are presented net of an allowance for doubtful accounts. The activityof the Company’s allowance for doubtful accounts for the years ended December 31,2003, 2004 and 2005 is presented in the following table:

 
| **Balance at**                   | ** ** | **Charged to**           | ** ** | ** **             | ** ** | **Balance at**           | ** ** |
|----------------------------------|------------|--------------------------|------------|------------------------|------------|--------------------------|------------|
| **Year Ended  December 31** | ** ** | **Beginning  of Period** | ** ** | **Income or  Expense** | ** ** | **Deductions  (1)** | ** ** | **End of  Period** | ** ** |
|                             |       |                     |       |                   |       |                     |       |   |   |
| 2003                             |       |                     | 58,427     |                   | 14,508     |                     | (29,354    | ) | 43,581 |   |
| 2004                             |       |                     | 43,581     |                   | (17,087    | )                        | (16,299    | ) | 10,195 |   |
| 2005                             |       |                     | 10,195     |                   | 8,231      |                     | (6,153     | ) | 12,273 |   |

 

----

(1)  Represents amounts written off asuncollectible accounts receivable.

 

**3.**                                      Debt

 

The Company has obtained a $250,000 revolving line of credit agreementwith a commercial bank. The line of credit expired in December 2004, whenit was renewed and extended through March 2006. The line is due on demand,but if no demand then in March 2006. The interest rate is subject tochange and is indexed to the bank’s prime rate. The rate at December 31,2005 was 9.25%. In connection with the line of credit, GlobalSCAPE entered intoa Commercial Security Agreement with the bank whereby GlobalSCAPE granted asecurity interest in all its accounts receivable and property and equipment. TheCompany borrowed $100,000 on September 11, 2003 under this agreement. Thisamount remained outstanding at December 31, 2003 and was repaid in February 2004.The Company does not intend to renew this line of credit.

 

**4.**                                      Commitmentsand Contingencies

 

**Capital Leases**

 

The Company had financed the acquisition of certain fixed assetsthrough capital lease obligations. These obligations were paid in full in 2004.As of December 31, 2005 GlobalSCAPE had no capital lease obligations.

 

Property and equipment at December 31, 2003 and 2004 includes$227,000 for assets held under capital leases, less associated accumulateddepreciation of $203,000 and $227,000, respectively. Depreciation for assetsheld under capital leases is included in depreciation and amortization expense.

 

45

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**Operating Leases**

 

Minimum future lease payments on non-cancelable operating leases foroffice facilities are as follows for the years ending December 31:

 

| 2006       |   | 190,659 |    |
|------------|--------|---------|---------|
| 2007       |   | 190,659 |    |
| Thereafter |   | 95,329  |    |
|       |   | $       | 476,647 |   |
|            |        |         |         |  |

 

This lease provides the Company with two successive 5-year renewaloptions. Operating lease expense amounted to approximately $180,000 in each of2003, 2004 and 2005.

 

**Contingencies**

 

The Company from time to time may beinvolved in litigation relating to claims arising out of its ordinary course ofbusiness. There are no pending claims against the Company that wouldhave a material adverse effect on the financial statements of the Company.

 

**5.**                                      RelatedParty Transactions

 

On June 11, 2002, ATSI sold its majority interest in GlobalSCAPE, Inc.to Brown and Mann-GlobalSCAPE Joint Venture, a Texas general partnership ownedby San Antonio-based investors Thomas W. Brown and David L. Mann. Contemporaneouslywith this transaction, GlobalSCAPE agreed to compromise and settle a $612,304inter-company balance owed to it by ATSI, which resulted in charges toGlobalSCAPE of $392,905. The balance was settled for (i) $200,000 in cashfrom ATSI; (ii) NTFC Capital Corporation’s release of GlobalSCAPE as aco-borrower on a capital lease executed by ATSI in 1999, and (iii) ATSI’sagreement to provide $50,000 worth of transition support services toGlobalSCAPE over the nine months ending March 11, 2003.

 

On March 30, 2004, the Company obtained a $200,000 line of creditwith the Brown and Mann-GlobalSCAPE Joint Venture. The line of credit wasavailable after June 21, 2004 if the Company failed to extend a line ofcredit with a bank and matured on December 31, 2004. The line of creditwith the partnership was not renewed. The interest rate was subject to changeand was indexed to the prime rate published in the Wall Street Journal. Inconnection with the line of credit, GlobalSCAPE entered into a CommercialSecurity Agreement with the Brown and Mann-GlobalSCAPE Joint Venture wherebyGlobalSCAPE granted a security interest in all its accounts receivable andproperty and equipment. The Brown and Mann-GlobalSCAPE Joint Venture is 70%owned by Thomas W. Brown and 30% owned by David L. Mann, both of whom aremembers of GlobalSCAPE’s Board of Directors. In October 2004 the Brown andMann-GlobalSCAPE Joint Venture distributed all shares held by the partnershipto its two partners with the exception of 17,856 shares, which were distributedin 2005.

 

**6.**                                      IncomeTaxes

 

Deferred income taxes reflect the net tax effects of temporarydifferences between the carrying amounts of assets and liabilities forfinancial reporting purposes and the amounts used for income tax purposes. Significantcomponents of the Company’s deferred tax assets and liabilities are related tothe following:

 

46

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| ** **                                  | ** ** | **2004** | ** ** | **2005** | ** ** |
|---------------------------------------------|------------|----------|------------|----------|------------|
| Total deferred tax liabilities              |       | $        | —     |     | $          | — |   |
|                                        |       |     |       |     |       |
| Deferred tax assets:                        |       |     |       |     |       |
| Accrued  expenses                           |       | —   |       | 14,828   |       |
| Allowance  for doubtful accounts            |       | 3,466    |       | 4,173    |       |
| Deferred  compensation                      |       | —   |       | 4,121    |       |
| Depreciation  and amortization              |       | 56,696   |       | 28,861   |       |
| Net  operating loss carryforwards           |       | 424,691  |       | —   |       |
| Total deferred tax assets                   |       | 484,853  |       | 51,983   |       |
| Valuation allowance for deferred tax assets |       | 484,853  |       | —   |       |
| Net deferred tax assets                     |       | $        | —     |     | $          | 51,983 |   |
|                                             |            |          |            |          |            |  |  |  |

 

A reconciliation of income tax expense and the amount computed byapplying the statutory federal income tax rate (34%) to income before incometaxes is as follows:

 
| ** **                                                  | ** ** | **2003** | ** ** | **2004** | ** ** | **2005** | ** ** |
|-------------------------------------------------------------|------------|----------|------------|----------|------------|----------|------------|
| Taxes computed at federal statutory rate                    |       | $        | (218,620   | )        | $          | 68,655   |       | $ | 546,650 |   |
| Increases (decreases) in taxes resulting  from:             |       |     |       |     |       |     |       |
| State taxes,  net of federal benefit                        |       | 924      |       | 983      |       | 703      |       |
| Non-deductible  incentive stock option compensation charges |       | —   |       | —   |       | —   |       |
| Other  non-deductible expenses                              |       | 2,581    |       | 2,368    |       | 4,113    |       |
| Change in  valuation allowance                              |       | 216,515  |       | (55,497  | )          | (484,853 | )          |
| Other                                                       |       | —   |       | (15,020  | )          | (2       | )          |
| Total                                                       |       | $        | 1,400      |     | $          | 1,489    |       | $ | 66,611 |   |

 

At December 31, 2005 the Company has utilized its available netoperating loss carryforwards for both financial reporting and Federal incometax reporting purposes.

 

**7.**                                      EmployeeBenefit Plan

 

The Company has a 401(k) plan that covers substantially all employeeswith at least six months of service. Under the plan, employees may electto contribute a percentage of their annual salary subject to the InternalRevenue Code maximum limitations. The plan provides for employer matching anddiscretionary contributions, the amounts of which are to be determined annuallyby the Board of Directors. The Company made contributions to the plan of$7,533, $6,910 and $11,120 for the years ended December 31, 2003, 2004 and2005, respectively.

 

**8.**                                      StockOptions and Stock Based Compensation

 

In January 1998, the Company approved the 1998 Stock Option Plan(the “1998 Plan”) for officers, other employees, directors, and consultants ofthe Company. Under the terms of the 1998 Plan, up to 728,571 shares of theCompany’s common stock may be granted in the form of incentive stockoptions or non-qualified stock options, awarded, or sold to officers, otheremployees, directors and consultants. As of July 31, 2001, no additionalgrants could be issued under the 1998 Plan.

 

In May 2000, the Board of Directors approved the 2000 stock optionplan (the “2000 Plan”) for key employees, non-employee directors, and advisorsof the Company. Under the terms of the 2000 Plan, up to 3,660,000 shares of theCompany’s common stock may be granted in the form of incentive stockoptions or non-qualified stock options. The maximum aggregate number of sharesof common stock that may be granted to any optionee during the term of the2000 Plan may not exceed 2,000,000. The 2000 Plan provides that thepurchase price per share for incentive stock options and non-qualified stockoptions shall not be less than the fair market value of the common stock on thedate of grant. The maximum term for an option granted is ten years from thedate of grant.

 

47

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The Company has adopted Statement of Financial Accounting Standards No. 123,“Accounting for Stock Based Compensation” (SFAS No. 123), and elected touse the intrinsic value method in accounting for its stock option plan inaccordance with Accounting Principles Board opinion No. 25, “Accountingfor Stock Issued to Employees” and related interpretations under whichcompensation expense is recorded to the extent that the current market price ofthe underlying stock exceeds the exercise price. No options were issued belowfair value for the years ended December 31, 2004 and 2005.

 

In December 2004, FASB issued Statement No. 123-R, *Share-Based Payment,*which establishesaccounting standards for transactions in which an entity receives employeeservices in exchange for (a) equity instruments of the entity or (b) liabilitiesthat are based on the fair value of the entity’s equity instruments or that may besettled by the issuance of equity instruments*.*Effective in the first quarter of 2006, SFAS 123-R will require usto recognize the grant-date fair value of stock options and equity basedcompensation issued to employees in the statement of operations. The statementalso requires that such transactions be accounted for using the fair–value-based method, thereby eliminating use of the intrinsic value method ofaccounting in APB No. 25, *Accountingfor Stock Issued to Employees,*which was permitted under Statement123, as originally issued. This change in accounting will be required in thefirst quarter of 2006 and will result in increased compensation expense for stockoptions over their vesting period.

 

During the second quarter of 2005, 469,000 options were granted tovarious employees at an average exercise price of $0.3172 per share.

 

**Supplemental Disclosures for Stock Options**

 

The following table shows the number of options granted, cancelled andexercised for all option plans for the three years ending December 31,2005.

 

| ** **                         | ** ** | **Number of** | ** ** | **Weighted Avg.**  | ** ** |
|------------------------------------|------------|---------------|------------|--------------------|------------|
| ** **                         | ** ** | **Shares**    | ** ** | **Exercise Price** | ** ** |
| 2003                               |       |          |       |               |       |
| Outstanding December 31, 2002 |       | 2,965,671     |       | $                  | 0.40       |   |
| Granted                            |       | 56,000        |       | 0.20               |       |
| Expired                            |       | 1,035,500     |       | 0.72               |       |
| Exercised                          |       | 130,000       |       | 0.07               |       |
| Outstanding December 31, 2003 |       | 1,856,171     |       | $                  | 0.24       |   |
|                               |       |          |       |               |       |
| 2004                               |       |          |       |               |       |
| Granted                            |       | 581,000       |       | 0.12               |       |
| Expired                            |       | 182,500       |       | 0.28               |       |
| Exercised                          |       | 284,600       |       | 0.01               |       |
| Outstanding December 31, 2004 |       | 1,970,071     |       | $                  | 0.24       |   |
|                               |       |          |       |               |       |
| 2005                               |       |          |       |               |       |
| Granted                            |       | 469,000       |       | 0.32               |       |
| Expired                            |       | 20,000        |       | 0.16               |       |
| Exercised                          |       | 24,900        |       | 0.36               |       |
| Outstanding December 31, 2005 |       | 2,394,171     |       | $                  | 0.26       |   |
|                                    |            |               |            |                    |            |  |  |

 

48

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The following table shows information about outstanding stock optionsat December 31, 2005.

 

| ** **                    | ** ** | ** **               | ** ** | **Options Outstanding**                             | ** ** | **Options Exercisable**                | ** ** |
|-------------------------------|------------|--------------------------|------------|-----------------------------------------------------|------------|----------------------------------------|------------|
| **Range of  Exercise Prices** | ** ** | **Options  Outstanding** | ** ** | **Weighted  Average  Remaining  Contractual  Life** | ** ** | **Weighted  Average  Exercise  Price** | ** ** | **Number of  Options** | ** ** | **Weighted  Average  Exercise  Price** | ** ** |
| $0.0132                       |       | 565,571                  |       | 4.89                                                |       | $                                      | 0.0132     |   | 565,571 |   | $ | 0.0132 |   |
| $0.12 - $0.20                 |       | 518,600                  |       | 8.61                                                |       | 0.1497                                 |       | 176,451 |   | 0.1512 |   |
| $0.31 -  $0.33                |       | 469,000                  |       | 9.46                                                |       | 0.3172                                 |       | — |   | — |   |
| $0.464                        |       | 841,000                  |       | 5.29                                                |       | 0.4640                                 |       | 841,000 |   | 0.4640 |   |
| $0.0132 - $0.464              |       | 2,394,171                |       | 6.73                                                |       | $                                      | 0.2607     |   | 1,583,022 |   | $ | 0.2681 |   |

 

**There were535,571 shares exercised in January 2006 at a weighted average exerciseprice of $0.0132 per share.**

 

**9.**                                      QuarterlyFinancial Information (unaudited)

 
| ** **                                           | ** ** | **Item 8B.    Fiscal Year 2004** | ** ** |
|------------------------------------------------------|------------|-------------------------------------------------|------------|
| ** **                                           | ** ** | ** **                                      | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| ** **                                           | ** ** | **1st Quarter**                                 | ** ** | **2nd Quarter** | ** ** | **3rd Quarter** | ** ** | **4th Quarter** | ** ** |
|                                                 |       |                                            |       |   |   |   |   |   |   |
| Total revenues                                       |       | $                                               | 1,172,137  |   | $ | 1,287,797 |   | $ | 1,270,223 |   | $ | 1,200,502 |   |
| Total operating expenses                             |       | 1,377,017                                       |       | 1,083,595 |   | 1,134,881 |   | 1,133,091 |   |
| Other Income (expense)                               |       | (720                                            | )          | — |   | (371 | ) | (560 | ) |
| Net income (loss) before provision for  income taxes |       | (205,600                                        | )          | 204,202 |   | 134,971 |   | 66,851 |   |
| Net income (loss)                                    |       | (205,600                                        | )          | 204,202 |   | 134,971 |   | 66,851 |   |
|                                                 |       |                                            |       |   |   |   |   |   |   |
| Net income (loss) per share:                         |       |                                            |       |   |   |   |   |   |   |
| Basic                                                |       | $                                               | (0.015     | ) | $ | 0.015 |   | $ | 0.010 |   | $ | 0.005 |   |
| Diluted                                              |       | $                                               | (0.015     | ) | $ | 0.014 |   | $ | 0.009 |   | $ | 0.005 |   |
| Weighted average shares outstanding:                 |       |                                            |       |   |   |   |   |   |   |
| Basic                                                |       | 13,488,619                                      |       | 13,638,995 |   | 13,773,219 |   | 13,773,219 |   |
| Diluted                                              |       | 13,488,619                                      |       | 14,154,174 |   | 14,303,786 |   | 14,367,215 |   |

 
| ** **                                    | ** ** | **Item 8C.    Fiscal Year 2005** | ** ** |
|-----------------------------------------------|------------|-------------------------------------------------|------------|
| ** **                                    | ** ** | ** **                                      | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| ** **                                    | ** ** | **1st Quarter**                                 | ** ** | **2nd Quarter** | ** ** | **3rd Quarter** | ** ** | **4th Quarter** | ** ** |
|                                          |       |                                            |       |   |   |   |   |   |   |
| Total revenues                                |       | $                                               | 1,422,381  |   | $ | 1,819,376 |   | $ | 1,723,685 |   | $ | 1,867,606 |   |
| Total operating expenses                      |       | 1,262,418                                       |       | 1,293,747 |   | 1,334,381 |   | 1,346,206 |   |
| Other Income (expense)                        |       | (328                                            | )          | (15 | ) | 4,424 |   | 7,417 |   |
| Net income before provision for income  taxes |       | 159,963                                         |       | 525,614 |   | 393,728 |   | 528,817 |   |
| Net income (loss)                             |       | 158,570                                         |       | 525,614 |   | 393,728 |   | 463,271 |   |
|                                          |       |                                            |       |   |   |   |   |   |   |
| Net income (loss) per share:                  |       |                                            |       |   |   |   |   |   |   |
| Basic                                         |       | $                                               | 0.012      |   | $ | 0.038 |   | $ | 0.029 |   | $ | 0.034 |   |
| Diluted                                       |       | $                                               | 0.011      |   | $ | 0.036 |   | $ | 0.025 |   | $ | 0.029 |   |
| Weighted average shares outstanding:          |       |                                            |       |   |   |   |   |   |   |
| Basic                                         |       | 13,773,219                                      |       | 13,773,219 |   | 13,776,969 |   | 13,792,523 |   |
| Diluted                                       |       | 14,366,506                                      |       | 14,584,284 |   | 15,582,248 |   | 15,794,293 |   |

 

49

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GlobalSCAPE released its Enhanced File Transfer product in November 2004,comparisons of GlobalSCAPE’s quarterly results from operations should take thisitem into consideration.

 

## **Item 9.**           Changes in and Disagreements withAccountants on Accounting and Financial Disclosure

##  

None.

 

###### **Item9A.**                Controlsand Procedures

###### ** **

As of the end of the period covered by this Annual Report, ourPresident and Chief Financial Officer carried out an evaluation of theeffectiveness of GlobalSCAPE’s disclosure controls and procedures (as definedSEC Rules 13a-15(e) and 15d-15(e) under the Securities ExchangeAct of 1934, as amended, (the “Exchange Act”)) and concluded that the controlsand procedures are effective in recording, processing, summarizing andreporting the information required to be disclosed by GlobalSCAPE in thereports it files with the SEC under the Exchange Act within the time periodsspecified in the SEC’s rules and forms.

 

There has been no change in our internal controls over financialreporting during the most recent fiscal quarter that has materially affected,or is reasonably likely to materially affect, our internal control overfinancial reporting.

 

###### **Item 9B.**                Other Information

###### ** **

None.

 

50

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# **PART III**

#  

## **Item 10.**    Directors and ExecutiveOfficers of the Registrant

##  

The information called for by Item 10 of Form 10-K as to Directorsis incorporated herein by reference to such information included in our ProxyStatement for the 2006 Annual Meeting of Stockholders to be held on June 1,2006 under the caption “Election of Directors.”  Also see Item 4A of Part I of this Form 10-K.The information called for by Item 10 of Form 10-K as to compliance with Section 16(a) ofthe Exchange Act is incorporated herein by reference to such informationincluded in our Proxy Statement for the 2006 Annual Meeting of Stockholders tobe held on June 1, 2006 under the caption “Executive Officers.”

 

GlobalSCAPE has adopted a Code of Ethics thatapplies to all its employees, including its President (its chief executiveofficer) and its Vice President of Finance and Operations (its chief financialofficer). GlobalSCAPE will provide a copy of its Code of Ethics to any personwithout charge upon written request to:

 

Thomas F. Farar

Chief Financial Officer

GlobalSCAPE, Inc.

6000 Northwest Parkway, Suite 100

San Antonio, Texas  78249

 

## **Item 11.**    Executive Compensation

##  

The information called for by Item 11 of Form 10-K is incorporatedherein by reference to such information included in our Proxy Statement for the2006 Annual Meeting of Stockholders to be held on June 1, 2006, under thecaption “Executive Compensation” except for those parts under the captions “BoardReport on Executive Compensation”.

 

## **Item 12.**    Security Ownership of CertainBeneficial Owners and Management and Related Stockholder Matters

##  

The information called for by Item 12 of Form 10-K is incorporatedherein by reference to such information included in our Proxy Statement for the2006 Annual Meeting of Stockholders to be held on June 1, 2006, under thecaption “Security Ownership of Certain Beneficial Owners and Management.”

 

## **Item 13.**    Certain Relationships andRelated Transactions

##  

The information called for by Item 13 of Form 10-K is incorporatedherein by reference to such information included in our Proxy Statement for the2006 Annual Meeting of Stockholders to be held on June 1, 2006, under thecaption “Certain Relationships and Related Transactions.”

 

## **Item 14.**    Principal Accountant Fees andServices.

##  

The information called for by Item 14 of Form 10-K is incorporatedherein by reference to such information included in our Proxy Statement for the2006 Annual Meeting of Stockholders to be held on June 1, 2006under the caption “Principal Accountant Fees and Services.”

 

51

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# **PART IV**

 

## **Item 15.**    Exhibits, Financial StatementSchedules

 

(a)(1)                    Financial Statements and Schedules

 

The following financial statements of GlobalSCAPE, Inc. are included in Item 8:

 

•                  Consolidated balance sheets – December 31, 2004 and 2005

 

•                  Consolidated statements of operations – Years ended December 31, 2003, 2004 and 2005

 

•                  Consolidated statements of stockholders’ equity – Years ended December 31, 2003, 2004 and 2005

 

•                  Consolidated statements of cash flows – Years ended December 31, 2003, 2004 and 2005

 

•                  Notes to consolidated financial statements – December 31, 2005

 

(2)                      Schedules not listed above have been omitted because they are not applicable or required, or the information required to be set forth therein is included in the Financial Statements or Notes thereto.

 

(3)                      Exhibits

 
| **Exhibit  Number** | ** ** | **Description**                                                                                                                                                                                                                        |
|---------------------|------------|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 3.1                 |       | Certificate of Incorporation of the Company  dated April 17, 1996 (Filed as Exhibit 3.1 to Form 10 filed May 12,  2000).                                                                                           |
| 3.2                 |       | Certificate of Renewal and Revival of  Certificate of Incorporation for the Company dated February 16, 1999  (Filed as Exhibit 3.2 to Form 10 filed May 12, 2000).                                                 |
| 3.3                 |       | Certificate of Amendment of Certificate of  Incorporation dated May 11, 2000 (Filed as Exhibit 3.3 to Form 10  filed May 12, 2000).                                                                                |
| 3.4                 |       | Certificate of Amendment to Certificate of  Incorporation dated September 5, 2000 (Filed as Exhibit 3.5 to Form 10,  Amendment No. 2, filed September 12, 2000)                                               |
| 3.5                 |       | Bylaws of the Company (Filed as Exhibit 3.4  to Form 10 filed May 12, 2000).                                                                                                                                            |
| 3.6                 |       | Amended and Restated Bylaws of the Company  effective as of September 1, 2000 (Filed as Exhibit 3.6 to Form 10,  Amendment No. 2, filed September 12 2000).                                                   |
| 3.7                 |       | Amended and Restated Bylaws of GlobalSCAPE  effective as of October 10, 2000 (Filed as Exhibit 10.1 to Form 8-K  filed October 10, 2000).                                                                          |
| 3.8                 |       | Amended and Restated Bylaws of GlobalSCAPE  effective as of January 30, 2003 (Filed as Exhibit 3.8 to Annual  Report on Form 10-K filed March 31, 2003).                                                           |
| 4.1                 |       | Specimen of Stock Certificate (Filed as Exhibit 4.1  to Annual Report on Form 10-K filed April 2, 2001).                                                                                                                |
| *10.1               |       | 1998 Stock Option Plan as amended May 13,  1999 (Filed as Exhibit 4.2 to Form 10 filed May 12, 2000).                                                                                                              |
| *10.2               |       | 2000 Stock Option Plan dated May 8,  2000 (Filed as Exhibit 4.3 to Form 10 filed May 12, 2000).                                                                                                                    |
| *10.3               |       | Form of 1998 Stock Option Plan Rights  Termination Letter Agreement of Directors to Agree Not to Claim Any Right of  Adjustment dated February 4, 2000 (Filed as Exhibit 4.6 to Form 10  filed May 12, 2000). |
| *10.4               |       | Form of 1998 Stock Option Plan Rights  Termination Letter Agreement for Employees and Consultants to Cancel Options  dated February 8, 2000 (Filed as Exhibit 4.7 to Form 10, filed  May 12, 2000).           |

 

52

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| **Exhibit  Number** | ** ** | **Description**                                                                                                                                                                                                                          |
|---------------------|------------|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| *10.5               |       | Form of 1998 Stock Option Plan Rights  Termination Letter of Officer to Agree Not to Claim Any Right of Adjustment  dated February 8, 2000 (Filed as Exhibit 4.8 to Form 10 filed May 12,  2000).               |
| *10.6               |       | Form of 1998 Stock Option Plan Rights  Termination Letter Agreement of Officer to Agree Not to Exercise Options  dated February 8, 2000 (Filed as Exhibit 4.9 to Form 10 filed May 12,  2000).                  |
| *10.7               |       | Form of 1998 Stock Option Plan  Reinstatement and Adjustment Letter for Employees dated December 19,  2000 (Filed as Exhibit 10.17 to Annual Report on Form 10-K filed April 2,  2001).                         |
| *10.8               |       | Form of Release and Indemnity  Agreement between GlobalSCAPE, Inc. and Employees dated December 19,  2000 (Filed as Exhibit 10.18 to Annual Report on Form 10-K filed April 2,  2001).                     |
| 10.9                |       | Commercial Lease Agreement between ACLP  University Park S.A. II, L.P. and the Company dated April 13, 1999  (Filed as Exhibit 10.1 to Form 10 filed May 12, 2000).                                                  |
| *10.10              |       | Release and Indemnity Agreement between  GlobalSCAPE, Inc. and Sandra Poole-Christal dated April 2, 2001  (Filed as Exhibit 10.17 to Annual Report on Form 10-K filed April 1,  2002).                          |
| *10.11              |       | Granting letter for 808,571 options to  Sandra Poole-Christal under GlobalSCAPE, Inc. 1998 Stock Option Plan  dated April 20, 2001 (Filed as Exhibit 10.18 to Annual Report on Form 10-K  filed April 1, 2002). |
| *10.12              |       | Bonus letter for Sandra Poole-Christal in  connection with grant of 808,571 options under 1998 Stock Option Plan (Filed  as Exhibit 10.19 to Annual Report on Form 10-K filed April 1,  2002).                            |
| *10.13              |       | Incentive Stock Option Agreement between  GlobalSCAPE, Inc. and Sandra Poole Christal dated April 20, 2001  (Filed as Exhibit 10.20 to Annual Report on Form 10-K filed April 1,  2002).                        |
| *10.14              |       | Form of Incentive Stock Option  Agreement under GlobalSCAPE, Inc. 2000 Stock Option Plan (Filed as Exhibit 10.21  to Annual Report on Form 10-K filed April 1, 2002).                                           |
| *10.15              |       | Employment Agreement between GlobalSCAPE, Inc.  and Charles R. Poole dated effective July 1, 2005 (Filed as exhibit 10.1  on Form 8-K filed June 20, 2005).                                                     |
| *10.16              |       | Incentive Stock Option Agreement between  GlobalSCAPE, Inc. and Charles R. Poole dated June 15, 2005 (Filed  as Exhibit 10.2 on Form 8-K filed June 20, 2005).                                                  |
| 21                  |       | Subsidiaries (Filed as Exhibit 21 on Form 10-K  filed March 24, 2005).                                                                                                                                                    |
| 23.1                |       | Consent of Helin, Donovan, Trubee &  Wilkinson, LLP (filed herewith).                                                                                                                                                           |
| 23.2                |       | Consent of Ernst & Young LLP  (filed herewith)                                                                                                                                                                                  |
| 31.1                |       | Rule 13a-14(a)/15d – 14(a) Certification  of Charles R. Poole, President and Chief Operating Officer of GlobalSCAPE, Inc.  (filed herewith).                                                                         |
| 31.2                |       | Rule 13a-14(a)/15d – 14(a) Certification  of Thomas F. Farar, Chief Financial Officer (filed herewith).                                                                                                                   |
| 32.1                |       | Certificate pursuant to 18 U.S.C. Section 1350,  as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.  (filed herewith).                                                                                      |

 

----

* Management Compensatory Plan or Agreement

 

53

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**Signatures**

 

Pursuant to the requirements of Section 13 or 15(d) of theSecurities Exchange Act of 1934, the registrant has duly caused this report tobe signed on its behalf by the undersigned, thereunto duly authorized, in SanAntonio, Texas on March 9, 2006.

 

 
| ** ** | ** ** | **GlobalSCAPE, Inc.**             | ** ** | ** **            |
|------------|------------|----------------------------------------|------------|-----------------------|
| ** ** | ** ** | ** **                             | ** ** | ** **            |
| ** ** | ** ** | ** **                             | ** ** |
|       |       |                                   | By:        | /s/  Charles R. Poole |   |   |
|       |       | Charles  R. Poole                      |       |                  |
|       |       | President  and Chief Operating Officer |       |
|       |       |                                   |       |
|       |       |                                   |       |
|       |       |                                   | By:        | /s/  Thomas F. Farar  |   |   |
|       |       | Thomas  F. Farar                       |       |                  |
|       |       | Chief Financial Officer                |       |                  |
|            |            |                                        |            |                       |  |  |  |

 

Pursuant to the requirements of the Securities Act of 1934, this reporthas been signed below by the following persons on behalf of the registrant inthe capacities indicated on March 9, 2006.

 

| **Signature**        | ** ** | **Title**                                     |
|----------------------|------------|-----------------------------------------------|
|                 |       |                                          |
| /s/ Charles R. Poole |       |                                          | President, COO and Director |
| Charles R. Poole     |       | (Principal Executive Officer)                 |
|                 |       |                                          |   |
| /s/ Thomas W. Brown  |       |                                          | Chairman of the Board and Director |
| Thomas W. Brown      |       |                                          |
|                 |       |                                          |   |
| /s/ David L. Mann    |       |                                          | Director |
| David L. Mann        |       |                                          |
|                 |       |                                          |   |
| /s/ Thomas F. Farar  |       |                                          | Chief Financial Officer, |
| Thomas F. Farar      |       | Treasurer, Secretary                          |
|                 |       | (Principal Accounting and Financial  Officer) |

 

54

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